Within the past decade, considerable progress has been made in measuring ex post portfolio performance. The two parameter risk-return dimension of investment performance as pioneered by Markowitz has been reduced to a single parameter which incorporates measures of both risk and return. Several different but related one-parameter measures of performance have been developed, notably by Sharpe [8], Treynor [11], and Jensen [3], and are commonly referred to as composite performance measures. Theoretically, the composite measures allow portfolios with different risks and returns to be compared directly.

The earliest successes in developing asset management theory focusing predominantly on short-term optimization of physical stock flow systems are due to Masse [13]; Arrow, Harris, and Marschak [1]; and Whitin [22]. This led to the development of burgeoning literature on what has come to be known as “inventory theory” followed by its application to cash management problems by Baumol [2]. In contrast to the conventional static analysis of Tobin [19] and Markowitz [12], Baumol's model incorporates what Hicks [11] referred to as “frictions” or the adjustment costs. More recently the pioneering works by Miller and Orr [14] Eppen and Fama [3], Weitzman [20], and Sethi [4] have sought to extend this basic model by incorporating different cash flow and operating cost assumptions.

George C. Philippatos, David N. Nawrocki, The Information Inaccuracy of Stock Market Forecasts: Some New Evidence of Dependence on the New York Stock Exchange, The Journal of Financial and Quantitative Analysis, Vol. 8, No. 3 (Jun., 1973), pp. 445-458

In this paper, a model is developed for deriving the implied fixed cost of a bond flotation. Using a sample of electric utility companies over the 1961–1970 period, implied fixed costs are computed for 318 bond issues. These fixed costs then are evaluated in an effort to cast light on whether companies behave optimally with respect to the size and frequency of bond issues. Regression results are consistent with the adjustment of debt issuing behavior in keeping with: (1) expectations about the future course of interest rates; (2) variable costs increasing at a decreasing rate with the size of individual issue; and (3) differences in the cost of carrying excess liquidity which arise from differences in quality rating. An estimate of the average fixed cost of issuing bonds is evaluated as is the debt issuing behavior of individual companies. Over all, the model and its testing give considerable insight into the implied fixed costs of issuing debt.

Over the years there has been a growing interest in the over-the-counter (OTC) trading of exchange-listed securities (known as the third market). Although the third market has flourished and its advantages have been expounded, it has not been possible to compare accurately the third market with organized exchanges because of an incomplete quotation system. On April 5, 1971, the National Association of Security Dealers Automatic Quotation (NASDAQ) system began including bid-and-ask quotations for 30 stocks listed on the New York Stock Exchange (NYSE); see Table 1.

In their provocative article that discusses risk as the probability of an investment's worth falling below some specified minimal value, Machol and Lerner observe that by this definition investments may be risky over a short time horizon but not over a long one [5, p. 484], and that a person who could invest in the stock market over a relatively long period of time without needing to withdraw capital during the period could invest with “relatively little worry” [5, p. 488]. The purpose of this comment is to examine the foregoing position rather more closely insofar as the time path of investment values is concerned. To this end, we model the value of an investment in the New York Stock Exchange Index, relative to its initial value, as a Markov chain. We assume that no part of the initial investment or dividends received on it is withdrawn before termination of the process, at which point the entire amount accumulated (which may be less than the initial investment) is realized. Values taken from a record of annual percentage changes in the New York Stock Exchange Index over the period 1940–1968 are then used to define a representative matrix of transition probabilities which describes the manner in which investment values can change from one period to the next. The probability distributions of relative investment values over differing lengths of time for which the investment may be held are then investigated using the Markov chain model.