Knowledge that Transforms

In recent years a major controversy has formed in the finance literature regarding the empirical evidence of the informational content of dividends. Despite considerable support for the position of dividend nontriviality by various studies, the work by Watts [13] represents a formidable challenge. Because of the close proximity of the firm's earnings and dividend announcement dates, the major issue of the dispute has centered on the identification and control of contemporaneous earnings information. In an attempt to settle this controversy, the present study evaluates and extends Watts' methodology.

This statement presents the usual perception of bond risk. It is striking in that it does not discuss what is, from a portfolio theoretic view, the risk of a bond––the covariance of its return with the returns of other assets. This is in contrast to the typical discussion of the riskiness of common stocks, where we find some discussion of systematic risk and the role it plays in determining equilibrium expected security returns.

Eli Talmor, Asymmetric Information, Signaling, and Optimal Corporate Financial Decisions, The Journal of Financial and Quantitative Analysis, Vol. 16, No. 4, Proceedings of 16th Annual Conference of the Western Finance Association, June 18-20, 1981, Jackson Hole, Wyoming (Nov., 1981), pp. 413-435

In this paper prices of corporate bonds are decomposed into elements associated with (1) the pure price of time, (2) the default risk of the agency rating class to which the bond is assigned, and (3) the unique risk and ancillary features of the bond itself.

The search for a distribution which accurately describes the behavior of stock price returns has generated a considerable amount of controversy. While it is well known that the traditionally used assumption of lognormality deviates in systematic ways from the empirically observed—the latter has fatter tails and a larger concentration of mass near zero—none of the alternatives that have been proposed over the years (Stable Paretian—Mandelbrot [5], Poisson mixture of; lognormal distributions—Press [10], scaled T distribution—Praetz [9], lognormal with nonstationary variance—Rosenberg [11], subordinate stochastic process—Clark [2]) has gained general acceptance.

The mean-variance model is precisely consistent with the expected utility hypothesis only in the special cases of normally distributed security returns or quadratic utility functions. There is little evidence, however, that security returns follow normal distributions (see [13] for references) and quadratic preferences can be shown to generate implausible results, exhibiting increasing absolute risk aversion in the Pratt [ll]–Arrow [1, 2] sense and displaying negative marginal utility after some finite wealth level. In addition, Hakansson [4] has shown that single–period, mean-variance-efficient portfolios can have disastrous consequences over time—even when return distributions are stationary. Such criticisms of the mean-variance approach within the Von Neumann-Morgenstern framework have prompted several writers to suggest that investors maximize the expected value of utility functions with more “realistic” properties, while others have criticized the single-period focus of the model. One popular alternative utility function is the logarithmic function which exhibits decreasing absolute risk aversion and (conveniently) leads to myopic decision processes through time (i.e., investors treat each period as if it were the last, basing investment decisions on that period's wealth and return distributions only [8, 4]). (Other utility functions with constant relative risk aversion—such as the power function—also imply myopic decision rules within a multiperiod setting.)

This study focuses on the risk-return characteristics of investments in the common stocks of U.S.–based multinational corporations (MNCs) and U.S. national corporations (NATLs). Findings follow from a comparison of the risk-adjusted performance of MNCs and NATLs using the framework of the capital asset pricing model (CAPM). Results of this comparison challenge assertions of earlier writers that marginal benefits or advantages accrue from investments in MNCs as compared to NATLs.

The form of the Pareto optimal general insurance contract has been investigated by Borch [5], Arrow [3], and Raviv [16]. This paper extends their work to the consideration of the optimal investment portfolio insurance contract. This is a contract whose payoff depends upon the investment performance of some specified portfolio of common stocks. Portfolio insurance differs from general insurance in two important ways. First, investment portfolio insurance lacks the property of stochastic independence between losses on different contracts which is characteristic of general insurance, and this has led some actuaries to question whether portfolio insurance contracts should be sold in view of the risks they pose for the solvency of insurance companies. Recent developments in the theory of option pricing suggest, however, that under certain assumptions an insurance company will be able to eliminate the risks associated with portfolio insurance contracts by following an appropriately defined investment strategy. Secondly, there exists a market for the pricing of investment risks, the securities market; and, under appropriate assumptions, the equilibrium price of portfolio insurance contracts may be determined without specification of the preferences of insurance companies. This permits consideration of insurance company preference functions to be dispensed with, in marked contrast to the earlier literature concerned with general insurance, which treats insurance company preferences symmetrically with those of the insurance purchaser. In addition, since the characteristics of the insured portfolio are known to the insurer, and the performance of the portfolio is beyond the control of the insured, portfolio insurance is not prone to the problems of adverse selection and moral hazard which are liable to arise in general insurance.

Marc R. Reinganum, A New Empirical Perspective on the CAPM, The Journal of Financial and Quantitative Analysis, Vol. 16, No. 4, Proceedings of 16th Annual Conference of the Western Finance Association, June 18-20, 1981, Jackson Hole, Wyoming (Nov., 1981), pp. 439-462

Stephen Figlewski, The Informational Effects of Restrictions on Short Sales: Some Empirical Evidence, The Journal of Financial and Quantitative Analysis, Vol. 16, No. 4, Proceedings of 16th Annual Conference of the Western Finance Association, June 18-20, 1981, Jackson Hole, Wyoming (Nov., 1981), pp. 463-476