Journal Article A Message from the President of the Society for Financial Studies Get access Joseph Williams Joseph Williams New York University Search for other works by this author on: Oxford Academic Google Scholar The Review of Financial Studies, Volume 1, Issue 1, January 1988, Pages 1–2, https://doi.org/10.1093/rfs/1.1.1 Published: 03 April 2015

The relationship between an investor's attitude toward risk and the shape of his preference functions has long been recognized in both the general portfolio problem and the mean-variance model. By contrast, the literature has largely ignored the connection between general measures of an investor's attitude toward risk and the shape of his mean-variance or mean-standard deviation indifference curves. Yet this relationship is significant. Through general measures of risk aversion, assumptions about an investor's behavior under uncertainty imply restrictions on indifference curves. Conversely, assumptions about indifference curves impose restrictions on an investor's behavior under uncertainty. The development of this relationship and its implications is the objective of this note.

Optimal policies for selling a risky depreciable asset with proportional taxes and transaction costs are derived for a representative investor who maximizes the market value of his investment. Also calculated are the market value of his investment and the competitive price of the depreciable asset. Depending upon the values of various parameters, the investor realizes either capital gains and no losses, capital losses and no gains, or neither gains nor losses. Additional properties of the solution are derived numerically.

Assuming continuous trading in continuous time with Brownian motion processes, the basic capital asset pricing model of Sharpe, Lintner, and Mossin is developed under arbitrary distributions of investors' beliefs consistent with available information. Results on the processing of information are reported, and properties of investors' portfolios are derived.

Brokerage contracts for many categories of real assets are characterized by a common, constant commission rate payable upon sale, exclusive agency, and contractual asking prices. For a large market in steady state, these conventional contracts produce in equilibrium no agency problem between a broker and his clients. Each broker spends the same time or effort selling each client's asset as the broker would spend on his own assets. As in standard agency problems, extra effort by a broker generates first-order stochastically dominant distributions of bids by potential buyers. Unlike standard agency problems, each broker can allocate his time or effort between selling the assets of his multiple clients and searching for new clients in competition with other brokers. Because brokers' time spent searching for new sellers is dissipative, entry by brokers is excessive in equilibrium.

[Brokerage contracts for many categories of real assets are characterized by a common, constant commission rate payable upon sale, exclusive agency, and contractual asking prices. For a large market in steady state, these conventional contracts produce in equilibrium no agency problem between a broker and his clients. Each broker spends the same time or effort selling each client's asset as the broker would spend on his own assets. As in standard agency problems, extra effort by a broker generates first-order stochastically dominant distributions of bids by potential buyers. Unlike standard agency problems, each broker can allocate his time or effort between selling the assets of his multiple clients and searching for new clients in competition with other brokers. Because brokers' time spent searching for new sellers is dissipative, entry by brokers is excessive in equilibrium.]

Markets for many real assets are characterized by sequential search followed by bilateral bargaining between matched buyers and sellers. For a category of real assets, the joint, intertemporal valuation problems of buyers, owners, and sellers, and the associated Nash pricing function are solved explicitly. In equilibrium, the average transaction price is a noisy, proportional random walk, and the liquidity premium is positive for matched owners. Depending on the values of the parameters, the liquidity premium can be substantial. In a related problem of optimal development with costly search, the optimal exercise point, cost of development, and value of the undeveloped asset are calculated analytically. With search, development can occur sooner and undeveloped assets have lower market values than the standard solution without search.

[A subgame perfect Nash equilibrium is characterized for an industry with dissipative costs of agency. In sequence, firms can enter the industry, raise capital with external debt and/or equity, invest in a capital-intensive technology or dissipate capital in perquisites, and finally produce output. For plausible values of two critical parameters, some firms forego in equilibrium investments with positive net present values. Although more managers would like their firms to invest in the capital-intensive technology, they cannot raise the required cash in the capital market. In equilibrium, the industry can have both a profitable core of large, secure, capital-intensive firms, with some debt but no unique optimal capital structure, and a competitive fringe of small, risky, labor-intensive firms. Even as the cost of entry converges to zero, capital-intensive firms can earn extraordinary profits, while all labor-intensive firms fail. With costly agency, access to capital can become a barrier to entry.]

A subgame perfect Nash equilibrium is characterized for an industry with dissipative costs of agency. In sequence, firms can enter the industry, raise capital with external debt and/or equity, invest in a capital-intensive technology or dissipate capital in perquisites, and finally produce output. For plausible values of two critical parameters, some firms forego in equilibrium investments with positive net present values. Although more managers would like their firms to invest in the capital-intensive technology, they cannot raise the required cash in the capital market. In equilibrium, the industry can have both a profitable core of large, secure, capital-intensive firms, with some debt but no unique optimal capital structure, and a competitive fringe of small, risky, labor-intensive firms. Even as the cost of entry converges to zero, capital-intensive firms can earn extraordinary profits, while all labor-intensive firms fail. With costly agency, access to capital can become a barrier to entry.