Knowledge that Transforms

D. Chinhyung Cho, Edwin J. Elton, Martin J. Gruber, On the Robustness of the Roll and Ross Arbitrage Pricing Theory, The Journal of Financial and Quantitative Analysis, Vol. 19, No. 1 (Mar., 1984), pp. 1-10

The Capital Asset Pricing Model has been challenged recently by several studies that point to certain anomalies in the capital market related to firm size. Banz [3] reported a nonlinear relation between the aggregate market value of a firm's common stock and the stock's mean return. He found that firms with small market values had large and positive residual returns over a period of at least 40 years. Reinganum [23] found that high earning-price (E/P) stocks had higher returns than low E/P-ratio stocks and that, after controlling for size, the E/P effect largely disappeared. Although they rejected the hypothesis that the anomalies are due to inefficiency in the capital market, the two authors are not able to identify the economic factors that might explain the effect of firm size on the functioning of the capital market.

The Standard Fixed Payment Mortgage (SFPM) has been the dominant mortgage instrument in the United States for the last 50 years, and for much of this period it has performed well. However, during periods of high and volatile rates of inflation, the SFPM suffers from severe weaknesses. Foremost among these problems, from the standpoint of the borrower, is the tilt in the stream of real mortgage payments toward the initial years of the mortgage. For consumers unconstrained by capital market imperfections, this tilt is unimportant. However, a consumer is typically unable to borrow against expected higher future income, or against the nominal capital gains that accrue to the owner of a house over the life of the mortgage. In addition, common practices of mortgage lenders often limit mortgage payments to some fraction of income at the time of purchase. Together, these liquidity constraints create a mismatch between the time sequence of mortgage payments and income, a mismatch that reduces the number of borrowers who qualify for financing and that limits the value of the house purchased by those who do obtain financing.

Controversy surrounds the Securities and Exchange Commission's (SEC) Rule 415 that went into effect in March 1982 and remained an experiment until it was permanenty adopted for large firms in November 1983. Rule 415allows a company to register all the securities it plans to issue over the next two years and then to sell someor all of the securities whenever it chooses. This procedure is known as a shelf registration. The purposes of Rule 415 are to simplify the registration of new corporate securities and to allow more flexibility in the way issues are underwritten.

Terry E. Dielman, Henry R. Oppenheimer, An Examination of Investor Behavior During Periods of Large Dividend Changes, The Journal of Financial and Quantitative Analysis, Vol. 19, No. 2 (Jun., 1984), pp. 197-216

Stephen M. Schaefer, Eduardo S. Schwartz, A Two-Factor Model of the Term Structure: An Approximate Analytical Solution, The Journal of Financial and Quantitative Analysis, Vol. 19, No. 4 (Dec., 1984), pp. 413-424

Geske derived in [1] expressions for the values of junior and senior debt and equity. In this paper, some confusion about these expressions is cleared up, and an error is corrected. We use the same notation as in [1].

Donald R. Chambers, Willard T. Carleton, Donald W. Waldman, A New Approach to Estimation of the Term Structure of Interest Rates, The Journal of Financial and Quantitative Analysis, Vol. 19, No. 3 (Sep., 1984), pp. 233-252

With the formation of a formal market for the trading of financial futures in October 1975, a renewed interest in the futures contract as an investment vehicle has emerged. The traditional approach was to view investing in futures as a way of off setting potential price risk associated with a given spot position. While these descriptive scenarios (see [3], [6], [10], [12], [13], [14], and [19]) adequately illustrate the traditional hedging strategy, their simplifying assumptions introduce a lack of realism into the investment process. The implication drawn from many of these articles is that, if one is interested in risk reduction, one should simply take the opposite position in the appropriate number of futures contracts to totally offset one's existing spot position.

The purpose of this paper is to analyze the errors made by professional forecasters (analysts) in estimating earnings per share for a large number of firms over a number of years. We have demonstrated in a previous paper that consensus (average) estimates of earnings per share play a key role in share price determination. In this paper, we examine consensus estimates with respect to the following questions: (1) What is the size and pattern of analysts' errors? (2) What is the source of errors? (3) Are some firms more difficult to predict than others? (4) Is there an association between errors in forecasts and divergence of analysts' estimates?