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I test the disposition effect, the tendency of investors to hold losing investments too long and sell winning investments too soon, by analyzing trading records for 10,000 accounts at a large discount brokerage house. These investors demonstrate a strong preference for realizing winners rather than losers. Their behavior does not appear to be motivated by a desire to rebalance portfolios, or to avoid the higher trading costs of low priced stocks. Nor is it justified by subsequent portfolio performance. For taxable investments, it is suboptimal and leads to lower after-tax returns. Tax-motivated selling is most evident in December. [ABSTRACT FROM AUTHOR]

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 main theme of Professor Fewing's paper can be summarized as follows. A change in the time preference rate effects the nondiversifiable risk of a stock. Such a change in the nondiversifiable risk is transmitted via the growth factor. Thus, the higher the growth rate, the larger are the changes in the nondiversifiable risk of a stock triggered by a change in the time preference rate. The change in the time preference rate and the change in the nondiversifiable risk are positively related. Economic rationale suggests that unless the change in the time preference rate differentially interacts with the cashflow stream, which is totally excluded from consideration in the paper, stocks of all corporations would be similarly affected by this change. That is, there would be no differential changes in the nondiversifiable risk of the stocks with varying degrees of growth resulting from an exogenous change in the time preference rate. This can be simply demonstrated using the author's final results contained in his equation (14). [ABSTRACT FROM AUTHOR]

Commercial paper sells at an extra discount if it matures in the next calendar year but Treasury bills do not. The discount is apparent in downward price shifts before the year-end, and upward price shifts at the turn of the year that are significantly correlated with the simultaneous returns to small stocks, and that cannot reflect tax-loss selling. Cross-sectional and time-series tests on prices, as well as flow of funds evidence on trades by institutional investors, indicate that both the debt and equity patterns reflect agency problems related to portfolio disclosures. [ABSTRACT FROM AUTHOR]

The article presents commentary about a paper written by E. Han Kim entitled "Miller's Equilibrium, Shareholder Leverage Clienteles, and Optimal Capital Structure," which was published in the May, 1982 edition of the "Journal of Finance." The author regards Kim's paper as a survey of research on optimal capital structure inspired by Merton Miller's article "Debt and Taxes." He discusses the portion of Kim's paper that contrasted complete and incomplete capital market environments, and notes the importance of tax arbitrage restrictions in understanding them.

In this paper, we examine leasing as a tax-arbitrage instrument. Analysis of a sample of UK leases presented in this paper suggests that lessors earn large positive NPVs. Our theoretical model seeks to explain these positive NPVs in terms of a market price for a scarce resource that we identify as scarce taxable earnings. Using these prices, the model permits a lessor to determine whether the profitability of a proposed set of lease contracts can be improved by writing a different set of contracts that makes better use of the lessor's taxable earnings. There may be two reasons why an initial portfolio of contracts may be suboptimal. Either there may be clienteles or the leasing market may be inefficient. Subsequently, we discuss reasons why the leasing market may be characterized by clienteles, and, using two different samples of leases, we test whether the leasing market is segmented and efficient. [ABSTRACT FROM AUTHOR]

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.

This article presents a discussion of a paper that examined how external financing activities of firms are usually accompanied by a decrease in their equity values. Some theories that have examined this concept are the theory of signalling with differential information, the theory of agency and the theory of liquidity, which was examined in the observed paper. The author notes that firms have reasons to hold money or liquid assets in order to maintain opportunities to invest in profitable projects. The author discusses how firms meet this liquidity need and offers suggestions on how to improve the model of liquidity theory.

The article presents commentary from M.J. Brennan about a paper written by Nicholas Barberis and Ming Huang (B&H) entitled "Mental Accounting, Loss Aversion, and Individual Stock Returns," which appeared in the August, 2001 issue of the "Journal of Finance." In that paper B&H analyzed the behavior of investors who are concerned about the returns of both their portfolios and the individual stocks that compose them. The author of the current paper observes that this represents a departure from modern portfolio theory. In his view B&H's analysis, while interesting and informative, must be approached with caution.

This paper analyzes how mutual fund performance relates to past performance. These tests are based on a multiple portfolio benchmark that was formed on the basis of securities characteristics. We find evidence that differences in performance between funds persist over time and that this persistence is consistent with the ability of fund managers to earn abnormal returns. [ABSTRACT FROM AUTHOR]

This paper tests the effectiveness of techniques proposed by: Scholes-Williams; Dimson; Fowler, Rorke, and Jog; and Cohen, Hawawini, Maier, Schwartz, and Whitcomb to control for bias in beta estimates from thin trading and price adjustment delays. Each technique produces beta estimates that reduce the amount of this bias, but the amount of reduction in the best case is only 29%. This paper extends previous work by providing evidence of the extent of bias from thin trading and price adjustment delays for OLS betas estimated using daily data. Further, the effectiveness of the Scholes-Williams, Dimson, FRJ, and CHMSW techniques for adjusting beta estimates for the bias created by thin trading and trading delays is investigated using a new approach which employs actual data and allows for the construction of portfolios with known true betas. This paper is divided into four parts. The next section discusses the data and methodology. Then the following two sections present the results and discuss limitations of the study. The final section provides a summary. [ABSTRACT FROM AUTHOR]

In this paper we will introduce and develop a nontraditional theory of portfolio selection. The theory assumes that investors choose their portfolios to have a certain minimax property which we will describe in detail below. As we will see in the next two sections, the minimax portfolios turn out to be identical to portfolios that are often recommended on other grounds. In this paper we have examined the implications of certain forms of minimax behavior in portfolio selection. Though minimax behavior is not truly optimal, there are reasons to suppose that it might approximate the behavior of some investors. One reason is the obvious discomfort that many decision-makers feel when forced to make decisions based on subjective probability distributions, particularly when those distributions were formed on the basis of vague information. One would not be surprised if a decision-maker sought to protect himself against the possibility that his distribution is incorrect. Portfolio selection seems a natural context for minimax behavior because of the enormous amount of information, both direct and indirect, that an investor must incorporate into his probability distributions. The results of this paper, which show that minimax behavior leads to reasonable portfolios of the sort we observe in practice, lend some support to the minimax hypothesis. [ABSTRACT FROM AUTHOR]

This article presents a discussion of a paper that examined exchange risk. The author notes that the main argument set forth in the paper is related to portfolio management and maintaining purchasing power in situations where inflation is ignored and too much home currency is included in the portfolio. The author comments that while this situation is possible, it is not a necessary outcome. The author notes that the commodities in the portfolio play a more significant role in determining how the portfolio performs than is stated in the paper.

One has to be impressed with the potential importance of the data base which Professors Cohn, et al. have been able to assemble and begin to analyze. The first report of their ongoing study, which was presented a year ago at these meetings, tantalized our expectations for learning more about the investment behavior of individuals--for long a relatively forgotten segment of the securities markets. A subsequent paper presented additional information on portfolio objectives, investor attitudes, decision processes, and portfolio composition--as well as insights on how these aspects of individual investors are interrelated. The issue of the present paper is straightforward: as individuals acquire greater wealth beyond their consumption needs, what do they do with it? Absolute and relative risk aversion are formal measures of what they do, and thus are often discussed in theoretical papers. While some theorists have proceeded without specification of investor utility functions beyond the sign of their first and second derivatives, other theorists have postulated additional properties, such as absolute and relative risk aversion, and even the functional form in some instances. In addition to its theoretical implications, the findings of this study by Professors Cohn, et al. should be of general interest to anyone teaching investment courses at any level. [ABSTRACT FROM AUTHOR]

Part I of this paper discusses briefly the methods used in the calculation of the variance--co-variance matrix and correlation coefficients and the nature and sources of the data. In Part II we present an analysis of correlation among pairs of domestic and foreign assets over different lengths of holding periods. Part III contains an analysis of correlation among pairs of domestic and foreign identical industries. The paper closes with the presentation of the influence exchange rate variations have on the stability of earnings from foreign assets. [ABSTRACT FROM AUTHOR]

Professor Renwick has presented an interesting and worthwhile overview of the portfolio problem. Observations on the divergence of thought and implementation with regard to the conceptualization and measurement of risk appear to be of particular value to theorist and practitioner alike. The paper is indeed meritorious in many additional respects, but there remain, at least in this observer's opinion, some rather serious deficiencies. It is to this latter set that the following comments are addressed. [ABSTRACT FROM AUTHOR]

This paper shows that the existence of managerial ability, combined with the labor contract prevalent in the industry, implies that the closed-end fund discount should exhibit many of the primary features documented in the literature. We evaluate the model's ability to match the quantitative features of the data, and find that it does well, although there is some observed behavior that remains to be explained. [ABSTRACT FROM AUTHOR]

This paper evaluates various explanations for the profitability of momentum strategies documented in Jegadeesh and Titman (1993). The evidence indicates that momentum profits have continued in the 1990s, suggesting that the original results were not a product of data snooping bias. The paper also examines the predictions of recent behavioral models that propose that momentum profits are due to delayed overreactions that are eventually reversed. Our evidence provides support for the behavioral models, but this support should be tempered with caution. [ABSTRACT FROM AUTHOR]

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 examines the consequences of putting the word "international" in front of Ross's Arbitrage Pricing Theory, or, in shortened form, of putting an "I" in front of "APT". Professor Solnik has played an important role in putting that same letter in front of another important acronym in asset pricing theory. The outcome of that effort was, of course, the IAPM, and it appears that it is largely dissatisfaction with the testability of that theory which motivates the work presented here. Professor Solnik discusses his work primarily in terms of international pricing and his results are, of course, interesting for that application. He also notes other potential applications, e.g. asset pricing with relative price uncertainty. First we want to discuss the theoretical considerations involved in extending the APT to an international setting and then consider what is gained on the empirical front by making this extension. [ABSTRACT FROM AUTHOR]

Academic finance has explored the effect of taxes on corporate capital structure in great detail. By contrast, the effect of taxes on the capital structure of partnerships, REIT's, and related entities has received little attention. The present paper shows that, under general conditions, the values of partnerships and REIT's are invariant to leverage, contradicting the sparse literature in the area. A proof similar to that of Modigliani-Miller is employed. The effect of real world imperfections is also examined. [ABSTRACT FROM AUTHOR]

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]

This paper provides some new insights about approximate factor structures, as defined by Chamberlain and Rothschild [2], and their implications for empirical tests. First, we show that any economy that satisfies an approximate factor structure can be transformed, in a manner that does not alter the characteristics of investor portfolios, into an economy that satisfies an exact factor structure, as defined by Ross [9]. Second, we show that principal components analysis represents just one of many methods of forming groups of well-diversified portfolios with no idiosyncratic risk in large samples. Correct factor loadings will be obtained by regressing security returns on any group of these portfolios. Our interpretations of the Chamberlain and Rothschild results also provide additional insights into the testability of the Arbitrage Pricing Theory. We show that securities cannot be repackaged to hide factors in the manner suggested by Shanken [10] without the variance of some of the repackaged securities approaching infinity in large economies. [ABSTRACT FROM AUTHOR]

The article presents a commentary on the paper "Yes, The APT is Taxable," by R. Roll and S. Ross. The author contends that nothing in the paper indicates that a refutable empirical hypothesis can be obtained through the arbitrage framework itself. He explains that the equilibrium models presented have much to offer, but are really generalizations of the mean-variance capital assets pricing model (CAPM), in multi beta form. The author also notes that the market portfolio plays no particular role in the theory.

For the risk-averse investor, consideration of estimation risk is important in selecting an expected-utility-maximizing portfolio. It has previously been shown that the composition of the tangency portfolio is unaffected by the recognition of estimation risk if the Full Covariance Model is used. Alternatively, if the Market Model is used, the composition of the tangency portfolio has been shown to be affected by the recognition of estimation risk. However, as is demonstrated in this paper, the effect will generally not be as substantive as previously believed and in many situations can be safely ignored. [ABSTRACT FROM AUTHOR]

In this paper a systematic procedure is developed to determine necessary conditions for all degrees of stochastic dominance. The previously known necessary conditions are specified as to which degrees of dominance they belong, and two new necessary conditions, a ranking of harmonic means and a ranking of algebraic combinations of the first three moments, are derived. [ABSTRACT FROM AUTHOR]

This paper addresses the investor's decision to employ multiple managers for the management of investment funds. Under conditions such that specialization of managers and diversification among managers are not motives for the use of multiple managers, the paper shows that risk sharing considerations may be sufficient. A model is developed in which the decision to use multiple managers is explicitly treated, and conditions are studied such that an increase or decrease in the number of managers would be desirable. Under some conditions, a multiple manager solution is preferred over a single manager solution. [ABSTRACT FROM AUTHOR]

In this paper, we have provided an analysis of the international extension of arbitrage pricing theory, where investors value returns of the same asset differently; the same analysis could be applied to a domestic framework with heterogeneous consumption tastes. The technical problems posed by currency translation and aggregation in the international CAPM do not arise in APT since factors are not constrained to be portfolios of the original assets. While APT is not utility based, it requires the definition of a riskless portfolio, hence the numeraire used to measure (real) returns matters. This paper shows that, if a factor model is believed to hold when asset returns are expressed in some arbitrarily chosen currency, this factor structure, as well as its major conclusions, is invariant to the currency chosen. The relation between factor coefficients when measured in different currencies has been investigated, as well as the pricing of the forward exchange rates (or national interest rate differentials) which depend on the covariance of the currency fluctuations with the same common factors. If investors hold homogeneous expectations as measured in some currency, the same m-factor model and pricing relation will apply for everyone and we can aggregate the ex ante specification to a market testable ex post relation. It follows that, whatever the numeraire used, the pricing relation (5) might be subjected to empirical scrutiny. Again, note that the IAPT says nothing about the size of the risk premia lambda[sub k], nor the number or origin of the common factors, but only specifies the linearity of the pricing relation. Tests of international asset pricing models have so far been scarce and inconclusive (e.g. Solnik (12), Stehle (13)). Major limitations come from data availability, but also from the technical problems involved in the exact identification of the ex ante efficient portfolios as stressed by Roll (6). Consumption based CAPM are not void of similar... [ABSTRACT FROM AUTHOR]

An observer of quantitative practices in the financial community of 1980 discovers that what is called “Modern Portfolio Theory” or MPT consists of two classes of models which appear to have little to do with each other although they are applied to the same market price behavior. The two classes of models are long range present value models, which are exemplified by dividend discount models of equity prices and yield to maturity pricing of bonds, and short run models of the behavior of total return which are provided by the various versions of Capital Asset Pricing Theory (CAPT). The former models contain only an ad hoc treatment of risk if it is treated at all, and the latter ones without exception model risk as short run total return volatility. CAPT models use a short time horizon, usually thought of as 30 to 90 days, with the price formation at the horizon implicit and undefined. The present value models of the equities markets have an infinite time horizon. After 90 days, the long term holder has received only 1-2% of the present value. Hence, where the horizon of the one leaves off virtually none of the value measure of the other has been achieved. Clearly, investors have radically varying investment horizons. With few exceptions, there exists no theoretical explanation of how these views can be in equilibrium with each other. This paper makes a beginning at the construction of a unified framework for discussing both points of view in a logically consistent manner. [ABSTRACT FROM AUTHOR]

The purpose of this paper is twofold. First, we examine the individual portfolio decisions when income from stocks and bonds is taxed at different rates. Second, a rationale for the existence of risky debt in the presence of leverage-related costs and differential personal income taxation is provided. Previous studies on capital structure with differential personal income taxation have ignored either the portfolio risk consideration and/or the possibility of losing personal and corporate interest tax shields due to insufficient taxable earnings. In Section I of this paper, both the portfolio risk consideration and the possibility of losing personal and corporate interest tax shields are explicitly introduced. This enables us to provide a rationale for the shareholder leverage clientele phenomenon within a mean-variance framework. We also demonstrate a non-corner solution for the optimal corporate capital structure in a tax environment similar to that of Miller's “Debt and Taxes”. In Sections II and III of this paper, Miller's world is further modified to include risky debt and the attendant costs. We re-examine and synthesize recent studies on the theory of optimal capital structure which have appeared since the publication of “Debt and Taxes”). [ABSTRACT FROM AUTHOR]

The existence of transaction costs explains why investors do not fully diversify their portfolios. This paper examines the implications of such limited diversification on equilibrium asset prices in the framework of the capital asset pricing model. In the pricing equation obtained here an asset's risk premium depends on a weighted average of its covariance with the market and its own variance. [ABSTRACT FROM AUTHOR]

This paper focuses on the impact of taxes on optimal corporate pension policy. The analysis is based upon an integration of corporate and individual shareholder considerations. The major conclusions are that a company should fully fund its pension plan and should invest the pension fund totally in bonds. [ABSTRACT FROM AUTHOR]

In many finance courses at schools of business throughout this country, students are often encouraged, if not required, to participate in a portfolio selection project. The project often takes the form of a "winner-take-all" contest, in which the objective is to select at the beginning of the semester the portfolio of securities which will realize the highest rate of return during the semester. The winner gets a prize; everyone else gets nothing. One unique feature of this kind of contest is that a near-miss counts exactly the same as missing by a mile; so that if, for example, the highest rate of return turns out to be 30% then a gain of 29.99% is worth no more than a 100% loss. One might expect that the rules for optimal portfolio selection in this "all or nothing" situation would differ considerably from the conventional rules. This paper confirms that expectation by proving three propositions regarding optimal portfolio selection in a winner-take-all environment. A major conclusion which emerges from the paper is that studies based upon the results of such contests may not have any relevance for testing propositions about investor behavior in a conventional setting. Similarly, teachers of finance seeking to give their students practice in applying the principles of conventional portfolio selection should avoid contests of the winner-take-all type. [ABSTRACT FROM AUTHOR]

The article corrects an error in a previous paper by Arditti and Levy (A&L) on portfolio efficiency. In that paper A&L maintain that the skewness in returns from investing over a certain number of periods in the same portfolio is downward-sloping. The authors demonstrate that this is incorrect, tracing the problem to improper expressions for inverse functions that A&L used in their derivation of skewness. The correct derivation is provided, along with data showing that the slope of skewness can be either rising or falling, depending on other factors.

Previous work by the authors has described how optimal portfolios can be assembled given various assumptions about the variance covariance arrangement of stock returns, and stipulating the existence of a risk-free asset. The current paper offers additional simplification by relaxing the requirement for a risk-free asset. The authors show how to construct a complete frontier of efficient portfolios for the single-index model, and for when identical correlation coefficients prevail among all stocks.

In this paper we have developed decision rules that allow one to reach optimal solutions to realistic portfolio problems without ever solving a mathematical programming problem. Furthermore, the characteristics of the stock that make it desirable are readily understood and calculated. In a forthcoming paper, we will show that similar (but more complex) results can be reached when we introduce multiple indices and more complicated correlation structures. [ABSTRACT FROM AUTHOR]

The purpose of this paper is to investigate the opposite case: What is the impact of ever lengthening revision horizon on the optimal portfolio of a mean-variance investor? We do not intend to examine in this paper what will be the overall division of the investors' wealth between the riskless asset and the risky portfolio but rather we will determine how in the framework of the mean-variance analysis the long-run investor will construct his risky portfolio. Neither do we intend to examine the adequacy of the mean-variance criterion for this investment in light of the considerable skewness of multiperiod multiplicative returns. The purpose of this paper is to investigate the opposite case: What is the impact of ever lengthening revision horizon on the optimal portfolio of a mean-variance investor? We do not intend to examine in this paper what will be the overall division of the investors' wealth between the riskless asset and the risky portfolio but rather we will determine how in the framework of the mean-variance analysis the long-run investor will construct his risky portfolio. Neither do we intend to examine the adequacy of the mean-variance criterion for this investment in light of the considerable skewness of multiperiod multiplicative returns. [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 basic assumptions typically made in capital asset pricing theory imply that investors should hold diversified portfolios of assets. In an earlier paper, we developed under these same assumptions theoretical models of investors' behavior at both the micro and macro levels and used these models to assess the form of investors' utility functions. However, new as well as previously unanalyzed data indicate that a large proportion of households do not hold diversified portfolios contrary to the implications of these assumptions. These data consist of (1) a special sample of 1971 Federal individual income tax returns and (2) the Federal Reserve Board's 1962 Survey of the Financial Characteristics of Consumers (SFCC). The purpose of this paper is to document the degree of diversification in individual portfolios, replicate our previous findings about the form of investors' utility function for households which do hold diversified portfolios, and finally develop an equilibrium condition of the aggregate demand for risky assets under heterogeneous expectations. [ABSTRACT FROM AUTHOR]

Modern theory of capital asset pricing focuses on the role of uncertainty. Until recently, the student of financial theory faced another kind of uncertainty. He could never be sure how any particular model under study should be compared with another standard work. The literature abounds with controversies over the relative merits and deficiencies of this or that contribution. The present paper retains the two-parameter framework and relaxes the assumption of exogenous endowments of financial assets. [ABSTRACT FROM AUTHOR]

The purpose of the Lessard study is to investigate the nature of the stochastic' dependence among stocks and relate such knowledge to both normative portfolio management and positive capital market theory. Specifically, it purports to investigate via multivariate analysis the implications of the dependence structure of security prices for:1. Capital asset pricing. 2. Normative investment decision making. Clearly, the paper is not theoretical in intent. Unfortunately, it is largely devoid of empiricism and particularly the type of empiricism to get much mileage out of the nature of the stochastic dependence among stocks. Indeed, knowledge of the nature of the stochastic dependence among stocks is not sufficient to discriminate between major competing capital asset pricing models or, for that matter, to shed light on any of the major controversies within this realm. [ABSTRACT FROM AUTHOR]

There exists a wide disparity between the theory and practice of capital budgeting. During the past fifteen years, the theory of capital budgeting has been characterized by the increased application of such analytical techniques as utility analysis, mathematical programming, probability and statistical theory. The practice of capital budgeting has no doubt changed at the same time, but business executives do not appear to have adopted many of the new techniques. The purpose of this paper is to compare current theory with practice: (1) to discuss the nature of the gap and the reason for its existence, and (2) to try to lessen this disparity by suggesting ways of modifying theory to make it more operationally meaningful. To aid discussion, this paper is divided into four sections: objective of financial management, risk analysis in investment decisions, profitability criteria for investment selection, and conclusions. It is difficult, if not impossible, to characterize the current theory of capital budgeting in a few words. By current theory, I shall mean the type of work on capital budgeting that appears in journals such as Management Science, Journal of Finance, Journal of Financial and Quantitative Analysis, and Engineering Economist. These theories generally make use of modern quantitative tools. [ABSTRACT FROM AUTHOR]

The purpose of this paper is to derive the three MM Propositions using the standard deviation-mean portfolio model in a market equilibrium context. This approach to some of the major issues of corporation finance enables us to derive these propositions in a somewhat more direct way than with the use of the risk-class assumption and the arbitrage proof of the MM paper. Instead, a model is substituted relating the maximization of stockholder expected utility to the selection of portfolios of assets to, finally, the financing and investment decisions within the corporation, A link will be provided between two branches of the field of finance that have so far been evolving more or less separately. [ABSTRACT FROM AUTHOR]

This paper investigates the relationship between portfolio choice and labor income risk in the National Longitudinal Survey of Youth 1979 Cohort. Permanent income risk (variability of shocks to income that have permanent effect) significantly reduces the share of risky assets in the household's portfolio, while transitory income risk (variability of shocks with no lasting effect) does not. This result provides strong evidence that households' portfolio choices respond to labor income risks in a manner consistent with economic theory. [ABSTRACT FROM AUTHOR]

This paper documents a close link between mispricing and liquidity by investigating stocks with high analyst disagreement. Previous research finds that these stocks tend to be overpriced, but that prices correct downwards as uncertainty about earnings is resolved. Our analysis suggests that one reason mispricing has persisted through the years is that analyst disagreement coincides with high trading costs. We also show that in the cross-section, the less liquid stocks tend to be more severely overpriced. Additionally, increases in aggregate market liquidity accelerate the convergence of prices to fundamentals. As a result, returns of the initially overpriced stocks are negatively correlated with the time series of innovations in aggregate market liquidity. [ABSTRACT FROM AUTHOR]

This paper uses evidence from a data set of 27 European IPOs to analyze how investors bid and the factors that influence their allocations. We also make use of a unique ranking of investor quality, associated with the likelihood of flipping the IPO. We find that investors perceived to be long-term holders of the stock are consistently favored in allocation and in out-turn profits. In contrast to Cornelli and Goldreich (2001), we find little evidence that more informative bids receive larger allocations or higher profits. Our results cast doubt upon the extent of information production during the bookbuilding period. [ABSTRACT FROM AUTHOR]

This paper documents that hedge funds did not exert a correcting force on stock prices during the technology bubble. Instead, they were heavily invested in technology stocks. This does not seem to be the result of unawareness of the bubble: Hedge funds captured the upturn, but, by reducing their positions in stocks that were about to decline, avoided much of the downturn. Our findings question the efficient markets notion that rational speculators always stabilize prices. They are consistent with models in which rational investors may prefer to ride bubbles because of predictable investor sentiment and limits to arbitrage. [ABSTRACT FROM AUTHOR]

This paper investigates the importance of idiosyncratic consumption risk for the cross-sectional variation in asset returns. We find that besides the rate of aggregate consumption growth, the cross-sectional variance of consumption growth is also a priced factor. This suggests that consumers are not fully insured against idiosyncratic consumption risk, and that asset returns reflect their attempts to reduce their exposure to this risk. The resulting two-factor consumption-based asset pricing model significantly outperforms the CAPM, and its performance compares favorably with that of the Fama-French three-factor model. [ABSTRACT FROM AUTHOR]

This paper examines how information becomes reflected in prices when investment decisions are delegated to fund managers whose tenure may be shorter than the time it takes for their private information to become public. We consider a sequence of managers, where each subsequent manager inherits the portfolio of their predecessor. We show that the inherited portfolio distorts the subsequent manager's incentive to trade on long-term information. This allows erroneous past information to persist, causing mispricing similar to a bubble. We investigate the magnitude of the mispricing. In addition, we examine endogenous information quality. In some cases, information quality increases when the manager's expected tenure decreases. [ABSTRACT FROM AUTHOR]