Knowledge that Transforms

Richard H. Bernhard, A Simplification and an Extension of the Bernhard-deFARO Sufficient Condition for a Unique Non-Negative Internal Rate of Return, The Journal of Financial and Quantitative Analysis, Vol. 15, No. 1 (Mar., 1980), pp. 201-209

The implications for portfolio behavior and asset prices of transaction costs are central to the analysis of numerous issues in economics. For example, questions involving the demand for the financial contracts issued by financial intermediaries are intimately tied to the existence of transaction costs. Thus the analysis of questions involving the nature of the demand for mutual fund shares, insurance contracts, mortgage loans, etc., and the form those contracts take require the explicit inclusion of transaction costs.

Jimmy E. Hilliard, Asset Pricing Under a Subset of Linear Risk Tolerance Functions and Log- Normal Market Returns, The Journal of Financial and Quantitative Analysis, Vol. 15, No. 5 (Dec., 1980), pp. 1041-1061

Where rates of return are perfectly correlated, risk reduction through diversification cannot be achieved. Where rates of return are less than perfectly correlated, however, then, to the extent that these interrelationships can be known, modern portfolio theory provides a framework in which risk reduction through diversification can be achieved. Markowitz was the first to give rigorous content to the concept of portfolio diversification [14], and to introduce a formulation for treating portfolio selection as a mathematical optimization problem. In order to facilitate application of his own covariance approach, Markowitz first suggested [15, pp. 96–101], and Sharpe later developed a market model formulation according to which it is assumed that the rates of return on various securities “are related only through common relationships with some basic underlying factor” [18, p. 281]. More than 25 years have passed since Markowitz introduced his original formulation, and the literature dealing with the portfolio selection problem that he identified has grown considerably since then. Unfortunately, many problems remain which prevent full and effective implementation of this framework for investment analysis.

Bradford Cornell, The Denomination of Foreign Trade Contracts Once Again, The Journal of Financial and Quantitative Analysis, Vol. 15, No. 4, Proceedings of 15th Annual Conference of the Western Finance Association, June 19-21, 1980, San Diego, California (Nov., 1980), pp. 933-944

Terry Dielman, Timothy J. Nantell, Roger L. Wright, Price Effects of Stock Repurchasing: A Random Coefficient Regression Approach, The Journal of Financial and Quantitative Analysis, Vol. 15, No. 1 (Mar., 1980), pp. 175-189

The rapid advancement of technology leading to quicker obsolescence, shorter life cycles, and more intensive competition has resulted in renewed emphasis on the abandonment and replacement decision in the analysis of investment projects. Once an investment was undertaken, many corporations in the past often abandoned a project only when it either suddenly ceased to function, or else when it became so unprofitable that abandonment was literally forced. Several authors have demonstrated that a project could be abandoned well before any of these terminal conditions existed. Robicheck and Van Home, for instance [14], showed that an asset could be abandoned even though it may be expected to generate positive cash flows in subsequent years. Dyl and Long (DL) [6], in a modification to the Robichek and Van Home (RVH) model regarding the year of abandonment, suggested that rather than abandoning a project at the earliest time–whenever the abandonment value exceeded the present value of all subsequent future flows– all possible cases of abandonment over the life of the asset should be considered. In this manner, the procedure is to select the highest net present value of an asset over all cash flow and abandonment possibilities. This result particularly holds when all projects have the same degree of risk and when there are frictionless markets and no capital rationing.

In the theoretical literature of finance, it has been assumed for some time that capital markets are efficient, with security prices reflecting all available information [10]. One purpose of this paper is to consider market efficiency in the context of rights offerings. It has recently been suggested, for example, that rights offerings afford positive abnormal returns [17, 18]. This view was immediately countered by the comment that the number of rights issued, and inversely the issue price, cannot affect the market value of the total exrights equity market [21, p. 44]. No empirical evidence was offered on either side, however.

Sharpe's market model [29] is widely used both by academic researchers and practitioners in finance, but it cannot be accepted with complete confidence until some of its basic assumptions are tested more thoroughly. The applicability, usefulness, and reliability of the model are functions of its conformity to real data, which in turn depends partly on the unresolved question of heteroscedasticity.

Recently the standard market model has been used to examine holding period returns of corporate bonds. These studies have involved issues such as: the impact of accounting earnings data on bond price behavior [5]; the relationship of bond betas and ratings [19, 21]; the effect of ratings changes on bond prices [27]; the relationship of bond betas to duration and yield [3, 13, 15]; bond performance of bankrupt and nonbankrupt firms [26]; and tests of the Capital Asset Pricing Model based on bond returns [7]. While the empirical appropriateness of applying the market model to common stock returns has been demonstrated, similar tests have not been conducted with regard to long-term corporate bonds. Section II of this paper will examine the assumptions of the normal error regression model when used in the form of the market model and applied to a sample of long-term corporate bonds during the early years of their lives. The issue of systematic changes in the regression parameters will be addressed in Section III. Lastly, conclusions will be presented in Section IV.