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The article presents commentary from Jessica A. Wachter about a paper written by Yacine Ait-Sahalia and Michael W. Brandt entitled (A&B) "Variable Selection for Portfolio Choice," which appeared in the August, 2001 issue of the "Journal of Finance." In that paper A&B employed conditional moments of return to select an optimal portfolio. The author of the current paper acknowledges the validity of their work for single-period investments, but raises questions about its suitability for investments that extend over multiple periods.

The article presents a response to the paper "Orthogonal Frontiers and Alternative Mean-Variance Efficiency Tests," by Bruce N. Lehmann. The author discusses some difficulties associated with the approach outlined in the original article, such as using unknown betas. The author highlights the main contribution of the paper, the introduction of an alternative procedure allowing researchers not to be restricted by the number of time-series observations and to use returns on many individual assets instead of forming portfolios.

The article presents views of the author on the paper by scholars Robert Grauer and Nils Hakausson entitled "Gains from International Diversification: 1968-85 Returns on Portfolios of Stocks and Bonds." The author addresses the underlying model employed in the research and the risk of estimation. He agrees with the authors of the original article that the mean-variance framework is not suited to determine the optimal multiperiodic investment policy. Several aspects of portfolio rebalancing are also discussed.

The article presents discussion regarding the 19867 paper "Optimal Portfolio Choice Under Incomplete Information," by G. Gennotte. The article discusses research done on investment decisions in a Merton/Cox Ingersoll & Ross production economy. The article states that Gennotte's paper provides two interesting observations: that an increase in the uncertainty regarding instantaneous expected returns of a certain production process will reduce its weight in the portfolio, and that the decisions of investors with logarithmic preferences behave as if the conditional means are the true ones, given that their estimates of expected returns are independent of the estimation error.

This paper demonstrates how Bayesian information may be analyzed as a variable input in determining an optimal bank portfolio and investigates the impact of information in a way that is statistically satisfactory. A portfolio model is developed, and the impact of information is analyzed. Information is treated as an economic input that is used up to the point where its predicted marginal benefit is exactly equal to its marginal cost, and, from there, the optimal demand for information is derived. A comparative-static analysis demonstrates that the reaction of optimal portfolio holdings to interest rate changes under variable uncertainty is dramatically different from portfolio behavior when uncertainty is exogenous. Finally, the elasticity of reserves with respect to scale is examined under the assumption of variable uncertainty. [ABSTRACT FROM AUTHOR]

The present paper examines a time state preference model of exchange under the assumption that individuals have time-state-independent multiperiod logarithmic utility functions. Prior contributions of Dreze and Modigliani and Myers to multiperiod state preference theory are static since there are no possibilities for trading in intermediate periods and individuals acquire in the current period their state-contingent consumption claims for all future periods. In contrast, the myopic property of time-state-independent logarithmic utility permits consideration of trading in all intermediate periods. Since the model deals only with exchange equilibrium, investment in real assets and production are assumed to be exogenous. Thus, the aggregate amount of consumption for the whole economy in each state in each time period is exogenous. The securities traded in the capital market are bundles of claims on end of period wealth contingent on particular states of the world. It is assumed that the structure of the capital market permits individuals to establish separate contingent claims for those states of the world on whose probability of occurrence beliefs differ. The present paper examines a time state preference model of exchange under the assumption that individuals have time-state-independent multiperiod logarithmic utility functions. Prior contributions of Dreze and Modigliani and Myers to multiperiod state preference theory are static since there are no possibilities for trading in intermediate periods and individuals acquire in the current period their state-contingent consumption claims for all future periods. In contrast, the myopic property of time-state-independent logarithmic utility permits consideration of trading in all intermediate periods. Since the model deals only with exchange equilibrium, investment in real assets and production are assumed to be exogenous. Thus, the aggregate amount of consumption for the whole economy in each state in each time... [ABSTRACT FROM AUTHOR]

The article presents a commentary on the paper "Mean-Variance Versus Direct Utility Maximization," by Y. Kroll, H. Levy, and H. G. Markowitz. The author acknowledges that the analysis satisfactorily resolved both the multiplicative and additive scaling difficulties. He notes however that the paper introduced a new set of problems because of the arbitrary nature of the expected utility ratio. The author says an appropriate approach would map expected utility values for all utility functions having the same rankings into the same values, for purposes of comparison.

This paper decomposes daily close to close returns into trading day and non-trading day returns. We discover that all of the average negative returns from Friday close to Monday close documented in the literature for stock market indexes occurs during the non-trading period from Friday close to Monday open. In addition, average trading day returns (open to close) are identical for all days of the week. January/firm size/turn-of-the-year anomalies are shown to be interrelated with day-of-the-week returns. [ABSTRACT FROM AUTHOR]

This article examines research that analyzed the difference between the compositions of a real mean-variance-efficient portfolio and a nominally efficient portfolio with the same expected return. The research found that the nominal efficient set and the real efficient set are either coincident or strictly disjoint. This paper is designed to show that the linear approximation has implications which are at variance with previous results on the utility of nominal versus real wealth, that the approximation also implies that two portfolios with the same expected nominal return will not in general have the same expected real return and the linear dependence between the vector of asset expected nominal returns and the vector of covariances with inflation and real constants.

The results of previous generalized Security Market Line (SML) tests of the Mean Variance (MV) and Linear Risk Tolerance (LRT) Capital Asset Pricing Models indicate that the models are empirically identical. A very widely accepted, but technically incorrect, explanation for the results is that with normal return distributions all expected utility maximizing risk-averse investors will pick MV portfolios. The paper shows that the generalized SML tests cannot distinguish between the MV model and a much wider variety of power utility LRT models than has previously been entertained. On the other hand, with approximately normal, or real world, return distributions the investment policies of the various models are shown to be different from each other, and from the MV policy in particular. To the extent the results of the portfolio selection calculations are robust, the results of, and implications drawn from, the tests of the macro pricing relations are not based on firm micro foundations. [ABSTRACT FROM AUTHOR]

In this paper three contrasting assumptions about prior knowledge concerning mu and Sigma have been considered. It was shown that as increased uncertainty is introduced, the risk associated with a given portfolio increases, but that the portfolios identified as efficient in one case remain efficient in the other cases. Although the efficient set contains the same portfolios in all three cases, the map of the set in risk-return space shifts, and this shift causes a change in the portfolio identified as optimal. In cases with only limited prior information differences in the optimal portfolios may be significant and, therefore, should not be ignored. [ABSTRACT FROM AUTHOR]

One explanation for the negative relationship between short-horizon stock returns and inflation is that inflation proxies (inversely) for expected future real output. In this paper, I examine the possibility that inflation also proxies for variation in real price/dividend ratios (excess returns). I show that when the covariance between real price/dividend ratios and inflation is nonzero, the relationship between returns and expected inflation differs for the two components of returns: dividend yields and capital gains returns. My empirical evidence demonstrates that dividend yields and capital gains are related differently to expected inflation in U.S. and foreign markets. [ABSTRACT FROM AUTHOR]

This paper presents a new test of conditional versions of the Sharpe-Lintner CAPM, the Jagannathan and Wang (1996) extension of the CAPM, and the Fama and French (1993) three-factor model. The test is based on a general nonparametric methodology that avoids functional form misspecification of betas, risk premia, and the stochastic discount factor. Our results provide a novel view of empirical performance of these models. In particular, we find that a nonparametric version of the Fama and French model performs well, even when challenged by momentum portfolios. [ABSTRACT FROM AUTHOR]

This paper applies the multi-period investment model to a universe of international securities on the basis of the simple probability assessment approach. Our principal findings are: 1) the gains from including non-U.S. asset categories in the universe were remarkably large (in some cases statistically significant), especially for the highly risk-averse strategies, 2) the gains from removing the no leverage constraint were more substantial than they were in the absence of non-U.S. securities, and 3) there is strong evidence of market segmentation in that the optimal levels of investment in U.S. securities were mostly zero in the presence of the non-U.S. asset categories. [ABSTRACT FROM AUTHOR]

The authors' main goal in this paper is to ascertain whether conventional measures of abnormal mutual fund performance are sensitive to the benchmark chosen to measure normal performance. They employ the standard CAPM benchmarks and a variety of APT benchmarks to investigate this question. They find little similarity between the absolute and relative mutual fund rankings obtained from these alternative benchmarks, which suggests the importance of knowing the appropriate model for risk and return in this context. In addition, the rankings are not insensitive to the method used to construct the APT benchmark. Finally, they find statistically significant measured abnormal performance using all the benchmarks. The economic explanation for this phenomenon appears to be an open question. [ABSTRACT FROM AUTHOR]

Duality theory is employed to provide necessary and sufficient conditions for portfolios on the minimum-variance frontier to have positive investment proportions in all assets. These conditions involve the feasibility of portfolios that have non-negative correlation with all assets and positive correlation with at least one. Using these results, several "qualitative" results concerning the signs of investment proportions in efficient portfolios are proved. It is argued that the conditions that ensure all-positive weights in efficient portfolios are intuitively compelling and are not unique to the CAPM. With large numbers of assets, however, the signs of weights in minimum-variance portfolios can be very sensitive to slight departures from these conditions due to, for example, sampling error. [ABSTRACT FROM AUTHOR]

This study analyzes the interaction between the optimal level of investment and debt financing. For this purpose, a model is structured in which a firm, facing an uncertain price, has to decide on its optimal level of investment and debt. The amount of investment sets a limit on output whose optimal level is determined after price is realized. The debt involved is risky (there exists a possibility of bankruptcy). The analysis proves that investment and its optimal financing have to be simultaneously determined and that a negative relationship exists between operating and financial leverage. We also demonstrate that as the tax rate increases, optimal capacity decreases and optimal leverage increases. An analysis of the impact of changes in the expected price shows that under some conditions, an increase in expected price would lead to an increase in optimal investment (firm size) and a decrease in optimal debt. [ABSTRACT FROM AUTHOR]

Security market line (SML) analysis, while an important tool, has never been fully justified from a theoretical standpoint. Assuming symmetric information and an inefficient index, we show that SML analysis can be grossly misleading, since, in general, efficient and inefficient portfolios can plot above and below the SML. On a more positive note, if SML analysis uses the return on a marketed riskless asset for the zero-beta rate, efficient portfolios must plot above the SML. Nonetheless, arbitrarily inefficient portfolios also plot above the SML. [ABSTRACT FROM AUTHOR]

Recently, the case for international portfolio diversification has been convincingly argued in the framework of mean-variance portfolio analysis by a number of researchers. However, virtually no empirical documentation exists concerning the best method for estimating the correlation structure of international share prices. In this paper, 12 models for estimating the international correlation matrix are presented and empirically tested relative to full historical extrapolation. The major evaluation criteria are the mean squared error and stochastic dominance based on the frequency distribution of the squared forecast errors. The results indicate that the National Mean Model strictly dominates all the others in terms of forecasting accuracy. [ABSTRACT FROM AUTHOR]

This paper examines the relation between the interest rate sensitivity of common stock returns and the maturity composition of the firm's nominal contracts. Using a sample of actively traded commercial banks and stock savings and loan associations, common stock returns are found to be correlated with interest rate changes. The co-movement of stock returns and interest rate changes is positively related to the size of the maturity difference between the firm's nominal assets and liabilities. [ABSTRACT FROM AUTHOR]

The impact of inflation on equilibrium returns in capital markets has been the subject of several articles in recent years. Chen and Boness [1], Friend, Landskroner and Losq [4], Long [7] and Roll [13] have all constructed general equilibrium models which incorporate the impact of uncertain inflation on returns. All of these authors have derived models in a mean-variance world utilizing methodologies similar to that first utilized by Mossin [9] or Merton [8]. The basic underlying tenet of mean-variance analysis is that for any given level of expected return investors wish to minimize the variance of return. In mean-variance equilibrium models the only risk that cannot be diversified away is the covariance of an asset's return with the market return. Assets which have the same covariance with the market have the same equilibrium required return. Thus in a mean-variance world if each member of the following pairs of assets had the same covariance with the market each member would have the same expected return: (a) a stock which was a perfect hedge against inflation versus one which was not, (b) a stock which was a perfect hedge against oil price changes versus one which was not, (c) a security that hedged against interest rate changes versus one which did not. In this article we break out of the limitations of the mean variance assumptions by utilizing the Arbitrage Pricing Theory (APT) of Ross [15], [16], [17]. This allows us to examine equilibrium returns when returns on alternative securities are impacted differentially by inflation and where investors care about (price) inflation sensitivity. [ABSTRACT FROM AUTHOR]

This paper presents an extension of the analysis conducted by two economists who examined the exact linkage between expected returns on risky corporate debts, unlevered equity, and levered equity resulting from pure capital structure rearrangements. The analysis implies the expected returns on debt, unlevered equity, and levered equity are determined simultaneously and linked together by the capital asset pricing equilibrium. The equilibrium relationship of the return expectations is developed and extended to demonstrate the effect of the financing decision on firm diversification relative to the market.

In this paper we will be concerned with questions of performance relating to timing. Our purpose is to identify in detail not only the return attributable to timing but also a previously unspecified "cost". We will do this under behavioral assumptions compatible with both single period, and multiperiod, models of portfolio performance and representative of the manager/investor decision making process.' [ABSTRACT FROM AUTHOR]

If investors wish to maximize the probability of achieving a given level of wealth within a fixed time, they should choose the "growth-optimum" portfolio; that is, the portfolio with highest expected fate of increase in value. This paper has examined the implications for observed common stock returns of all investors selecting such a portfolio. Given some widely-used (and useful) aggregation assumptions, the growth-optimum model implies that the expected return ratio E[(1 + R[sub j])/(1 + R[sub m])] is equal for all securities. This implied equality of expected return ratios was utilized in analysis of variance tests with New York and American Exchange listed stocks from 1962-1969 in order to ascertain the basic validity of the growth-optimum model. The model was well-supported by the data. The growth-optimum model was compared algebraically to Sharpe-Lintner theory, which is probably the most widely-used portfolio result in empirical work. A close correspondence was demonstrated between their qualitative implications. For example, both models imply that an asset's expected return will equal the risk-free interest rate if the covariance between the asset's return and the average return on all assets, Cov(R[sub j], R[sub m]), is zero. For most cases, the growth-optimum model also shares the Sharpe-Lintner implication that an asset's expected return will exceed the risk-free rate if and only if Cov(R[sub j], R[sub m]) > 0. There are, however, some cases of highly-skewed probability distributions where this implication does not follow for the growth-optimum model. A close empirical correspondence between the two models was demonstrated for common stock returns. The procedure (1) estimated returns and risk premia implied by the two models from time series; (2) calculated cross-sectional relations between estimated returns and risks; and (3) compared the cross-sectional relations to the theoretical predictions of the two models. They could not be distinguished ... [ABSTRACT FROM AUTHOR]

We investigate whether prospect theory preferences can predict a disposition effect. We consider two implementations of prospect theory: in one case, preferences are defined over annual gains and losses; in the other, they are defined over realized gains and losses. Surprisingly, the annual gain/loss model often fails to predict a disposition effect. The realized gain/loss model, however, predicts a disposition effect more reliably. Utility from realized gains and losses may therefore be a useful way of thinking about certain aspects of individual investor trading. [ABSTRACT FROM AUTHOR]

We investigate how the market for corporate control (external governance) and shareholder activism (internal governance) interact. A portfolio that buys firms with the highest level of takeover vulnerability and shorts firms with the lowest level of takeover vulnerability generates an annualized abnormal return of 10% to 15% only when public pension fund (blockholder) ownership is high as well. A similar portfolio created to capture the importance of internal governance generates annualized abnormal returns of 8%, though only in the presence of "high" vulnerability to takeovers. The complementarity effect exists for firms with lower industry-adjusted leverage and is stronger for smaller firms. [ABSTRACT FROM AUTHOR]

While many studies document that the market risk premium is predictable and that betas are not constant, the dividend discount model ignores time-varying risk premiums and betas. We develop a model to consistently value cashflows with changing risk-free rates, predictable risk premiums, and conditional betas in the context of a conditional CAPM. Practical valuation is accomplished with an analytic term structure of discount rates, with different discount rates applied to expected cashflows at different horizons. Using constant discount rates can produce large misvaluations, which, in portfolio data, are mostly driven at short horizons by market risk premiums and at long horizons by time variation in risk-free rates and factor loadings. [ABSTRACT FROM AUTHOR]

In this paper, I set up scenarios where the mean-variance capital asset pricing model is true and where it is false. Then I investigate whether the coefficients from regressions of population expected excess returns on population betas, and expected excess returns on betas and size, allow us to distinguish between the scenarios. I show that the coefficients from either ordinary least squares or generalized least squares regressions do not allow us to tell whether the model is true or false. [ABSTRACT FROM AUTHOR]

This paper examines an asset pricing model in which the Sharpe-Lintner CAPM and the zero-beta CAPM are special cases. The model allows the ratio of expected market risk premium to market variance, the conditional expected excess returns, and the risks to change over time. The results are found to be sensitive to the choice of the portfolio formation techniques. Significant time variability is shown in the conditional expected excess asset returns and risks and also in the reward-to-risk ratio. [ABSTRACT FROM AUTHOR]

Tests of asset-pricing models are developed that allow expected risk premiums and market betas to vary over time. These tests exploit the relation between expected excess return and current market values. Using weekly data for 1963 through 1982 on ten common stock portfolios formed according to equity capitalization, a single-risk-premium model is not rejected if the expected premium is time varying and is not constrained to correspond to a market factor. Conditional mean-variance efficiency of a value-weighted stock index is rejected, and the rejection is insensitive to how much variability of expected risk premiums is assumed. [ABSTRACT FROM AUTHOR]

An uninformed observer using the tools of mean variance and security market line analysis to measure the performance of a portfolio manager who has superior information is unlikely to be able to make any reliable inferences. While some positive results of a very limited nature are possible, e.g., when there is a riskless asset or when information is restricted to be “security specific,” in general anything is possible. In particular, a manager with superior information can appear to the observer to be below or above the security market line and inside or outside of the mean-variance efficient frontier, and any combination of these is possible. [ABSTRACT FROM AUTHOR]

We show that the set of expected return vectors, for which an observed portfolio is mean variance (MV) efficient, is a two-parameter family. We identify ten ways to specify the time series behavior of the two parameters; the result highlights a number of inconsistencies involved in MV modelling. For each of the cases, it permits the inference of the time series of expected return vectors, as well as all the other Capital Asset Pricing Model (CAPM) variables, compatible with a known covariance matrix and the observed time series of market value weights. The empirical work shows that there are substantial case-to-case differences in the time series of mean vectors and many of them are quite different from the constant mean vector envisioned in tests of the CAPM. [ABSTRACT FROM AUTHOR]

The article focuses on decision rules to solve portfolio problems, make selections, and construct optimal portfolios. Procedures in a single-index model and Press's model define multivariate stable distributions and explain how to rank securities for selection that will simplify computations, clarify the security's characteristics, and develop the optimal portfolio. Mean variance, riskless assets, scale parameter of the market index, and the algorithm for returns in nonnormal stable distributions are mentioned.

Most of the recent research in investments has assumed a single-period horizon for all investors. The present study has offered an EV model allowing for investors with different planning horizons. It was found that for the case of only-risky assets the single-period EV-efficient frontier also provides k-period EV-efficient frontiers and, thus, the optimal decision of the k-period investor will be a one-period efficient portfolio. Also, based on the admittedly restrictive assumption of expected quadratic utility maximizers, it was found that investment horizon affects portfolio choice. Consequently, knowledge of one's utility function is not sufficient for determining his choice of portfolio. To wit, two investors with the same utility function but different investment horizons will choose different portfolios (in the [mu[sub 1],omega[sub 1]] space), and two investors with different utility functions and different planning horizons can choose the same portfolio (in the [mu[sub 1],omega[sub 1]] space). In addition, the analysis of the only-risky securities case provided some intuitively appealing results. For example, short-term investors choose riskier portfolios than long-term investors. With the inclusion of the riskless security into the portfolio, the equivalence among efficient frontiers for different horizons is no longer valid. In general, two efficient portfolios obtain different combinations of risky securities, and it is possible that some securities are not at all represented in some k-period market portfolios, M[sub k]. Furthermore, we argued about the inefficiencies of the overall clearing market portfolio. However, no effort was made to obtain equilibrium prices for individual securities. We feel that this task might prove to be formidable since it requires knowledge of the proportions of investor groups segmented according to length of investor horizon. It appears that equilibrium relationships in terms that are beyond potentially observable ... [ABSTRACT FROM AUTHOR]

The random walk theory consists of two distinct hypotheses, one economic, the other statistical. The economic argument assumes security markets are, for all practical purposes, efficient markets such that no investor can earn a systematically superior return. The statistical argument, on the other hand, asserts that, for any particular security, price changes are independent random variables. If the statistical hypothesis is to be completely consistent with the economic hypothesis, it is not sufficient simply for successive price changes to be independent, but rather price changes must be mutually stochastically independent and not just pairwise independent. If efficient markets exist, then mutual independence follows. Tests of the economic hypothesis are usually constructed so as to prove or disprove that, following some mechanical rule, a certain investment strategy can, or cannot, earn a greater return than a simple buy-and-hold strategy [1]. The buy-and-hold strategy under efficient markets is an optimal strategy since it minimizes transaction costs. [ABSTRACT FROM AUTHOR]

Growth in capital expenditures conditions subsequent classification of firms to portfolios based on size and book-to-market ratios, as in the widely used Fama and French (1992, 1993) methods. Growth in capital expenditures also explains returns to portfolios and the cross section of future stock returns. These findings are consistent with recent theoretical models (e.g., Berk, Green, and Naik (1999)) in which the exercise of investment-growth options results in changes in both valuation and expected stock returns. [ABSTRACT FROM AUTHOR]

We show that corporate investment decisions can explain the conditional dynamics in expected asset returns. Our approach is similar in spirit to, but we introduce to the investment problem operating leverage, reversible real options, fixed adjustment costs, and finite growth opportunities. Asset betas vary over time with historical investment decisions and the current product market demand. Book-to-market effects emerge and relate to operating leverage, while size captures the residual importance of growth options relative to assets in place. We estimate and test the model using simulation methods and reproduce portfolio excess returns comparable to the data. [ABSTRACT FROM AUTHOR]

We study equilibrium firm-level stock returns in two economies: one in which investors are loss averse over the fluctuations of their stock portfolio, and another in which they are loss averse over the fluctuations of individual stocks that they own. Both approaches can shed light on empirical phenomena, but we find the second approach to be more successful: In that economy, the typical individual stock return has a high mean and excess volatility, and there is a large value premium in the cross section which can, to some extent, be captured by a commonly used multifactor model. [ABSTRACT FROM AUTHOR]

We study asset allocation when the conditional moments of returns are partly predictable. Rather than first model the return distribution and subsequently characterize the portfolio choice, we determine directly the dependence of the optimal portfolio weights on the predictive variables. We combine the predictors into a single index that best captures time variations in investment opportunities. This index helps investors determine which economic variables they should track and, more importantly, in what combination. We consider investors with both expected utility (mean variance and CRRA) and nonexpected utility (ambiguity aversion and prospect theory) objectives and characterize their market timing, horizon effects, and hedging demands. [ABSTRACT FROM AUTHOR]

Several recent studies suggest that equity mutual fund managers achieve superior returns and that considerable persistence in performance exists. This study utilizes a unique data set including returns from all equity mutual funds existing each year. These data enable us more precisely to examine performance and the extent of survivorship bias. In the aggregate, funds have underperformed benchmark portfolios both after management expenses and even gross of expenses. Survivorship bias appears to be more important than other studies have estimated. Moreover, while considerable performance persistence existed during the 1970s, there was no consistency in fund returns during the 1980s. [ABSTRACT FROM AUTHOR]

This article presents an examination of a mean-variance model of portfolio selection. The author notes that this model indicates that more of an asset is not necessarily a good thing, investors are typically only willing to take on a certain amount of risk even if the asset is performing well. The model that the author has presented indicates what this upper level of investment is and identifies the conditions that are most likely to facilitate this level of investing. The author discusses what the optimal portfolio looks like and examines how risk can influence the decisions an investor makes.

Existing literature on the management of accounts receivable and the optimal credit and pricing policy has recognized for some time that the product-pricing and the credit-policy decisions are interdependent and should be determined jointly. As pointed out above, however, attempts to integrate these two areas have at best been ad hoc. Either the pricing decision is assumed to be given and effort is concentrated on the credit-granting decision, or the criteria used for the decisions are at odds with those generally accepted in modem finance theory.
Applying a discrete-time contingent-claim analysis to the credit and pricing decisions under uncertainty, we have not only integrated the two decisions successfully, but have also analyzed their interactions within the wealth-maximization framework consistent with the modem theory of corporate finance. By recognizing the inherent uncertainties in both customer cash flows and quantity demanded, we have not only endogenized the default probabilities in the model explicitly, but have also captured the interactive effects between the two decisions. The analysis of the model has provided intuitive interpretations. [ABSTRACT FROM AUTHOR]

Empirical tests are reported for Ross' [48] arbitrage theory of asset pricing. Using data for individual equities during the 1962-72 period, at least three and probably four "priced" factors are found in the generating process of returns. The theory is supported in that estimated expected returns depend on estimated factor loadings, and variables such as the "own" standard deviation, though highly correlated (simply) with estimated expected returns, do not add any further explanatory power to that of the factor loadings. [ABSTRACT FROM AUTHOR]

The article refers to the implied duration strategy in bond portfolio management and discusses how the generalized immunization theorem can be a minimax strategy for creating a diversified portfolio where the minimal rate of return is maximized over a multi-period planning horizon. With immunization as a minimax or maximin strategy, the portfolio of coupon bonds stochastically dominate the pure discount bonds portfolio. The conditions for immunization are explained in an investment model that includes an instantaneous interest rate function and convex functions of the random shift parameter. The Fishburn-Bawa-Lindenberg risk measure, capital asset pricing model, expected utility, and zero coupon bonds are mentioned.

The article examines market risk adjustment in project valuation. The problem of valuation in the presence of market risk is reduced to a problem of valuation given that the market price of risk is zero. Assumptions are stated which lead to the use of an intertemporal Capital Asset Pricing Model (CAPM), regarding perfect markets, securities, and investor preferences. Three examples of the use of the intertemporal CAPM are presented, including the valuation of an asset, the pricing of a european call option, and the determination of the optimal capital structure of a firm.

The article focuses on portfolio selection in an economy with short sales restrictions. The author examines the portfolio selection problem faced by an investor holding non-marketable assets such as human capital or occupational assets, and cannot short-sell marketable and risky assets. Assumptions made in previous research concerning the feasibility of short-selling marketable assets are relaxed. It is shown that in an economy with marketability and short-sales restrictions, an investor will act to maximize terminal wealth.

"Investment for the long run," as defined by Kelly [7], Latane [8] [9], Markowitz [10], and Breiman [1] [2], is concerned with a hypothetical investor who neither consumes nor deposits new cash into his portfolio, but reinvests his portfolio each period to achieve maximum growth of wealth over' the indefinitely long run. (The hypothetical investor is assumed to be not subject to taxes, commissions, illiquidities and indivisibilities.) In the long run, thus defined, a penny invested at 6.01% is better--eventually becomes and stays greater--than a million dollars invested at 6%. When returns are random, the consensus of the aforementioned authors is that the investor for the long run should invest each period so as to maximize the expected value of the logarithm of (1 + single period return). The early arguments for this "maximum-expected-log" (MEL) rule are most easily illustrated if we assume independent draws from the same probability distribution each period. [ABSTRACT FROM AUTHOR]

The article examines conflicting views of bonds and stocks as alternatives in a risky investment portfolio. The author tests the hypothesis that the higher mean yield of stocks is offset by the lower variance of bond yields. Details relating to the composition of portfolios tested are discussed. The results of the research indicate that the probability of garnering higher yields with a portfolio of bonds, or even a mixed portfolio of bonds and stocks, relative to a portfolio composed entirely of stocks is extremely small.

The article focuses on the determination of a quantitative expected rate of return on U.S. common stock investments. In particular, the 1966 Fisher-Lorie study is reviewed, addressing its estimate of 9.3%. Questions are raised regarding the study's accuracy, bringing into debate the relevancy of the time span utilized due to its proximity to the 1929 Stock Market Crash. A new time series is derived from 1967-1972 and alternative estimates are given to predict broad market performance with managed portfolios between 6.5% and 8%.

This article presents the author's reply to a comment on his article titled "Portfolio Theory and the Problem of Foreign Exchange Risk." The author responds to the points made in the comment on his article and notes that the author failed to recognize that the problem facing mangers of foreign exchange risk is optimization in the currency dimension where exogenously given flows of payables and receivable are denominated in currencies which minimize risk for all expected returns. The author reiterates several of his fundamental points including that his simulations are case-by-case currency hedging decisions are suboptimal and that every decision made by a multinational corporation should include a decision on the optimal currency in which to denominate payments and receipts.