Knowledge that Transforms

Robert Forsythe, Gerry L. Suchanek, The Impossibility of Efficient Decision Rules for Firms in Competitive Stock Market Economies, The Journal of Financial and Quantitative Analysis, Vol. 17, No. 4, Proceedings of the 17th Annual Conference of the Western Finance Association, June 16-19, 1982, Portland, Oregon (Nov., 1982), pp. 555-574

James A. Brickley, Discussion: Empirical Evidence on Dividends as a Signal of Firm Value, The Journal of Financial and Quantitative Analysis, Vol. 17, No. 4, Proceedings of the 17th Annual Conference of the Western Finance Association, June 16-19, 1982, Portland, Oregon (Nov., 1982), pp. 501-502

The valuation of the firm in the context of the Capital Asset Pricing Model (CAPM) of Sharpe [22] and Lintner [18] brings into a new focus the product ion-investment decisions of the firm faced with demand and cost uncertainty. The market value of the firm and the level of systematic risk which arise from its product ion-investment decisions become items of primary importance. Although there are earlier treatments of the real determinants of valuation and risk in a dynamic context (e.g., Thomadakis [24] and Myers and Turnbull [20]), the case of a firm which experiments for the acquisition of information can furnish new insights.

It is often desirable to know whether or not a risky asset's beta coefficient has changed and, if so, at what point in time the change occurred. For example, this knowledge is of obvious importance to beta-using security analysts and portfolio managers. As another example, a given theory may imply that a particular firm's beta should have changed at different points in time. Investigators may want to test such a hypothesis. Furthermore, tests are frequently performed on the effects of events on residuals of the market model, tests requiring the assumption of beta stability. For these, and possibly other reasons, it is useful to be able to detect that a change in beta did, in fact, take place as well as, in some instances, identifying the point in time at which the change took place.

Linda M. Kahn, Discussion: Multiperiod Pension Plans and ERISA, The Journal of Financial and Quantitative Analysis, Vol. 17, No. 4, Proceedings of the 17th Annual Conference of the Western Finance Association, June 16-19, 1982, Portland, Oregon (Nov., 1982), pp. 633-635

Hassan Tehranian, Billy P. Helms, An Empirical Comparison of Stochastic Dominance among Lognormal Prospects, The Journal of Financial and Quantitative Analysis, Vol. 17, No. 2 (Jun., 1982), pp. 217-226

Ram T. S. Ramakrishnan, Anjan V. Thakor, Moral Hazard, Agency Costs, and Asset Prices in a Competitive Equilibrium, The Journal of Financial and Quantitative Analysis, Vol. 17, No. 4, Proceedings of the 17th Annual Conference of the Western Finance Association, June 16-19, 1982, Portland, Oregon (Nov., 1982), pp. 503-532

Recently, agency theory has become popular as a means of explaining the structure of contracts between various classes of economic agents. Oftentimes the contracts of interest represent sharing rules for the payoffs that result from some production activity. In the usual two-party model of the contracting problem, one party designated the principal delegates authority for decisions affecting production to another party designated the agent. Typically, the assumptions made about the consequences of the agent's actions are that they are associated with effort on the part of the agent for which the agent (but not the principal) has disutility, and that greater effort will result in higher payoffs from production in every state of nature. Moral hazard is then introduced by assuming that the principal is unable to observe the agent's effort, or to infer what effort the agent applied through an ex post observation of the payoff that results.

While the literature in finance is replete with studies on stock betas, bond betas have, to this day, not attracted much attention. This is quite understandable because much of the finance literature addresses stock betas in the context of the single period Capital Asset Pricing Model (CAPM). In the single period model, the risk-free rate (if it exists) is assumed to be constant over the period in question. Since the interest rate is fixed and investors are required to hold these default-free bonds over the entire period, interest rate risk, and, consequently, systematic risk for bonds do not exist. However, if the constant risk-free rate assumption is relaxedand investors are allowed to trade “intra period, ” (say continuously), Merton [4] has argued that an Intertemporal Capital Asset Pricing Model can be derived. Using Merton's framework, Jarrow [3] has recently derived a systematic risk measure for bonds. The primary intent of this paper is to investigate the effect of yield changes on the systematic risk of bonds. As we will demonstrate, the impact of yield changes on bond betas depends on several (sometimes complex) relationships between yields, duration, and bond prices. We derive conditions under which bond betas increase/decrease and show that the elasticity of duration with respect to yields and the sign of the initial beta of a bond will determine the manner in which yield changes affect bond betas.

Fewings [5] and Myers and Turnbull [13] have arrived at diametrically conflicting conclusions regarding the effect of growth on risk as measured by beta, the relative systematic risk in the Sharpe-Lintner-Mossin (SLM) capital asset pricing model. Fewings states his result in an unequivocal way: “…systematic capitalization risk of common stocks is undoubtedly a positive function of the rate of growth of expected corporate earnings” ([5, p. 53]) Myers and Turnbull, on the other hand, state their result in a more conditional form, making the result depend on the nature of market expectations revisions but conclude that “increasing the growth rate decreases B …” ([13], P. 327).