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In this article we present some empirical evidence which indicates that attempts to represent the probability distribution of the rates of return on common stocks by a member of the stable Paretian family of distributions, with 1 < alpha < 2, may be misleadingand in fact may not produce an adequate fit to observed rates of return. We offer an alternative probability model for describing rates of return based on the hypothesized phenomenon of a changing variance. We test the "goodness of fit" of our model vis-a-vis a stable Paretian model for several series of rates of return, Finally we propose an extension of the stability test of Fama and Roll [6]. [ABSTRACT FROM AUTHOR]

The amount of risk involved is often one of the important considerations in the evaluation of proposed investments. This paper is concerned with the derivation of the type of explicit, well-defined, and comprehensive information that is essential for an accurate appraisal of a risky investment. It is shown how, under certain assumptions, such information in the form of the probability distribution of the present worth, annual cost, or internal rate of return of the proposed investment can be derived. The derivation and use of this information is then illustrated by an example. [ABSTRACT FROM AUTHOR]

Returns and findings from three strategies of data collection are compared. Each strategy contains personal interviews, telephone interviews, and mail questionnaires in different combinations--one mainly personal, one mainly telephone, and one mainly mail. All three strategies are based on area probability samples of households in Alameda County, California. The test was made on two separate studies, with identical questionnaires used in all strategies within each study. The responses from the three strategies were found to be highly comparable. Rate of return and rate of completeness of questionnaires were high for all three; substantive findings were virtually interchangeable; and there was little difference in validity. The only important difference was cost per interview which varied considerably by strategy. [ABSTRACT FROM AUTHOR]

Decision-making processes usually involve time-consuming and costly operations of observation and communication of the state of the environment and generation and implementation of appropriate actions. Collectively these activities may be called computational and the procedure required to carry them out may be called an algorithm. If the environment is changing stochastically the fixed computational delay involved in operating the algorithm yields obsolete actions resulting in reduced expected return. The loss as a function of delay is a measure of efficiency of the algorithm which depends upon the stochastic properties of the environment. If it is possible to reduce the loss by employing a faster algorithm at a higher cost, the algorithm may be optimally designed and selected from a given family. [ABSTRACT FROM AUTHOR]

The article presents an approach to capital budgeting that involves formal recognition of the fact that future cash flows are not known with certainty. The uncertainty is incorporated in the analysis by the utilization of probability theory. The approach referred to as the probability approach to capital budgeting. For purposes of describing the probability approach to capital budgeting the net present value of an investment will be used as a measure of the worth of the investment. If an investor wishes to use the rate-of-return approach instead of the net present value approach, the essentials of the probability approach to capital budgeting would be the same. In order to understand the probability approach to capital budgeting, one must be familiar with certain concepts from probability theory. A probability beliefs approach has been suggested in connection with the portfolio selection problem and could be adapted to the capital budgeting problem. Another approach might be suitable in certain cases that would involve the use of historical data.

The analytical utility and managerial acceptability of three expected value maximizing (EV) project selection model forms were assessed within five different development R&D performing organizations. Utility was assessed in terms of the capabilities of the models for prescribing higher value portfolios than those actually implemented by the R&D managers. Value was expressed in terms of profit, return on investment, expenditures on unsuccessful efforts and funds unexpended. Acceptability was measured in terms of the manager's willingness to adopt the models on the bases of their assessed utilities, their general performances and their perceived attributes. Although one of the EV model forms was found to have high utility with regard to all five organizations studied, it was acceptable in only two of these organizations. In general, high utility was not found to be either an inherent characteristic of these EV model forms or an important consideration for their adoption by the R&D managers. Overall, the models were largely irrelevant and managerially unacceptable with respect to the development projects and the selection/allocation processes studied here. [ABSTRACT FROM AUTHOR]

In a problem of decision making under uncertainty, the payoff is random, obeying some probability distribution. The distribution depends upon both the problem faced and the action taken by the decision maker. For example, in the selection of a portfolio, funds are allocated among securities, each of which has an associated distribution over the return it yields. The allocation results in a composite probability distribution over the total return from the entire portfolio. Although it is typical to select an action, which in turn implies a resulting distribution, we suggest in the present paper that it may sometimes be appropriate to select a probability distribution directly, or to view the problem abstractly as though the distribution were to be developed directly. We envision the decision maker selecting a most preferred distribution over payoffs via modification of an existing probability distribution at a direct monetary cost. Thus the family of distributions from which the decision maker can choose is implicitly defined by initial wealth, the original distribution, and the modification cost function. A formal statement of a class of problems for which our direct approach may be appropriate is developed, followed by examples. The illustrations cover problems of preventive maintenance for a machine subject to failure, pricing of a product under threat of rival entry, and planning a risky R and D project. [ABSTRACT FROM AUTHOR]

This paper provides models for economic enterprises or projects whose returns vary randomly in time and which are subject to termination or "ruin" provided assets or net worth fall to a prescribed level. In particular, strategies for dealing with environmental changes, innovations, and catastrophe are considered. [ABSTRACT FROM AUTHOR]

Recently evidence has come forth which suggests that empirical probability distributions of returns on securities conform better to stable Paretian distributions with infinite variances than to the normal distribution. Using a generalized form of a technique proposed by Sharpe [17] in a recent issue of this journal, this article develops a portfolio analysis model for a stable Paretian market. The article also shows the range of conditions under which diversification is a meaningful economic activity, even though probability distributions of returns on individual securities have infinite variances. [ABSTRACT FROM AUTHOR]

Accounting information influences many decisions, but little is known about the way in which this influence is exerted in particular classes of decisions. If the facilitation of decisions is taken as the purpose of accounting, then accounting measurement methods ought to be evaluated in terms of their influence on the decision-making process. The article looks at permitted rates of return for privately owned natural gas distribution utilities. It attempts to relate differences in these rates of return with differences in accounting methods used. It is observed that as compared to many other decisions, the regulatory decision is fairly well standardized. In addition, the output of the decision is a single unambiguous number. For these reasons the regulatory decision is studied with expectations of a greater probability of obtaining meaningful results than would be the case with well-structured decisions. Finally, whether decision-makers are influenced in their decisions because of fixation or because of their choice of a particular method of measuring an accounting variable, the fact that decisions may be influenced by the related accounting process points to a need for greater research efforts directed at finding objective criteria for selection among alternative accounting methods for particular purposes.

This article presents a reply to a comment on a paper that presented a utility function in order to examine the variables that explain the required rate of return on stock for an investor. The author addresses the notion that he assumes a cubic utility function in the theoretical portion of his paper. The author states that he uses a general utility function and attempts to clarify the misunderstanding of this application. The author also defends the variables that are presented in the paper, noting that they were necessary in the development of a testable model.

This article presents comments on the introduction of probabilities and present value calculations into the analysis of gift tax. While the verbal description is formulated in terms of present value, it is actually future value which is calculated. While either of these may be used to choose amongst alternatives, two future values cannot be compared if they are not carried to the same date. The estate tax liability is calculated on the rather strange assumption that the taxpayer will die with certainty when exactly reaching his expected life.

Under the assumption that individuals are single-period maximizers of the expected utility of their future wealth, this essay extends the mean-variance security valuation model developed by Sharpe [10], Lintner [4, 5, and 6], and Mossin [7 and 8] to a general parameter-preference model, with and without the simplifications of homogeneous subjective probabilities and the existence of a risk-free security. Results with quadratic and cubic utility are developed as special cases. [ABSTRACT FROM AUTHOR]

Recent theoretical and empirical work in portfolio theory has exhibited a natural evolution from the two-moment EV model popularized by Markowitz through the higher moment models to selection on the basis of the entire probability function. This latter approach, referred to as the Stochastic Dominance (SD) approach to portfolio selection, has been shown to be theoretically superior to all of the "moment methods" and has been the focus of an increasing volume of empirical work. In comparison with the EV model, however, the SD approach has one potentially significant deficiency from the standpoint of empirical testing. With a given set of portfolios to evaluate, the computer processor time required for the determination of the EV efficient set is quite short. One can calculate and sort means and variances on several hundred portfolios in a matter of seconds. In contrast, the processor time required for the determination of the SD efficient set for the same number of portfolios can be prohibitive. The purpose of this paper is to examine the factors responsible for the relatively time-consuming nature of empirical tests of SD efficiency and to present the major results of our search for efficient algorithms for conducting SD tests. Section I briefly examines the time-consuming nature of the tests for SD efficiency. Section II presents and evaluates; our most efficient algorithms for obtaining true SD efficiency results. Section lit examines an approach that yields approximate SD efficiency results with further reductions in required processor time. [ABSTRACT FROM AUTHOR]

Someone has said that maternity is a matter of fact, while paternity is, at best, a matter of opinion. Concerning the field to which this issue of the Journal is devoted, however, there is little difference of opinion — Harry Markowitz is almost universally considered to be the father of portfolio analysis. The essence of the theory appeared in his 1952 article, although the full exposition was not available until several years later. [ABSTRACT FROM AUTHOR]

This article reviews the formulation of the constrained capital budgeting problem. The article compares the merits of integer programming and continuous linear programming as methods of solving this problem. The paper discusses capital constraints and the question of an appropriate objective function. Additional constraints are presented and problems arising because of the binary nature of capital projects are discussed. Some attempts have been made to include probability considerations in mathematical programming approaches to capital budgeting.

This article analyzes the relationship between stochastic dominance (SD) and mean-semivariance (ES) criteria. This paper contains two main results. First, there are good conceptual bases for anticipating greater consistency between ES and second SD (SSD) rules than between mean-variance (EV) and SSD rules. In particular, with one possible and relatively minor exception (identical mean and semivariance, the efficient set of portfolios derived from the ES rule with semivariance calculated around a fixed point is a subset of the SSD efficient set.

Presents information on a study which applied probabilistic models to management planning and control in accounting. Mathematical expression of nonprobabilistic approach to management planning and control; Problem with the traditional nonprobabilistic approach and probabilistic approach.

The P-model objective of chance-constrained programming reflects the desire of management to maximize the probability of achieving or exceeding a given level of performance. This paper explores the implications of being able to make a sequence of decisions with the P-model objective function, and introduces some new possibilities for the P-model objective function that arise from the sequential nature of the problem. However, it is shown that, except for a special form of the objective function, the maximization in the sequential problem is not of a quasiconcave function, so that local optimality conditions are not sufficient to guarantee that a proposed solution is a global optimum. An example is worked out in detail to illustrate the computations involved for the objectives considered. [ABSTRACT FROM AUTHOR]

This paper treats the following problem. How much money should be invested at time to at an interest rate of I for a time T such that the probability of the funds required "K(T)" exceeding those available "X(T)" equals at most p. That is P{K(T) > X(T)} ≤ p, where X(T) = X(t0) exp {I(T - t0)}. The parameters I, T, X(T) and K(T) are taken to be random variables. The theory to solve the stated problem is presented and solutions to certain specific cases are given. [ABSTRACT FROM AUTHOR]

A short-range control method for property-liability insurance company managers is outlined and illustrated. Basically the procedure is one of choosing an operating profit level as a company objective and making intelligent manipulations of underwriting and investment policies to maximize the probability of achieving the goal. Use is made of probabilistic approaches to prediction of underwriting experience as well as the general probability and mathematical programming model of Markowitz for managing investment portfolios. The necessary steps for introducing the plan into an insurance company are listed and discussed. [ABSTRACT FROM AUTHOR]

The Committee on General Insurance Terminology has tentatively defined risk as ‘uncertainty as to the outcome of an event when two or more possibilities exist.’ This article criticizes this definition on the grounds that (1) the word ‘uncertainty’ is ambiguous, (2) the definition forces intuitively unsatisfactory conclusions, and (3) the definition blocks basic quantitative study of risk. The article suggests that these three difficulties can be overcome if risk is defined as the objective probability that the actual outcome of an event will differ significantly from the expected outcome. [ABSTRACT FROM AUTHOR]

The article discusses some of the theoretical problems of the cash yield (CY) and prime rate index (PR) of convertible bonds. Since most convertible bonds currently being issued are offered to investors at prices around par, differences between cash yields and yields to maturity tend to be rather insignificant. Accounting Principles Board (APB), attempted to justify its choice of the CY/PR index on the grounds first that it represents a practical, simple and readily calculable basis for making decisions, and, second, that it has a sound empirical basis founded on a relatively high degree of correlation between the prime rate and alternative yield indices. In essence, the Board recommended an eminently operational procedure having several obvious, serious theoretical flaws and questionable predictive ability. The APB's decision to compare cash yields on risky securities with an essentially riskless rate not only creates the relative bias but also tends to reduce absolutely the probability that any convertible issue will be classified as the equivalent of common stock.

The article presents some empirical evidence on the influence of one kind of contemporary accounting message on investors' actions. Investors' actions result from investors' directed thinking processes. The objective of such processes is the construction of transformational strategies, each of which is a behavioral scheme that has some probability of transforming a problematic present state of affairs into a more desirable future state of affairs. The nature of the transformational strategies formulated by investors will be determined by the present beliefs, motives, attitudes, and expectations of investors. The transformational strategies formulated by an investor represent schemes for intervening in an empirical process in order to control his future experiences. During the construction of such strategies, events are predicted and the dimensions and scope of the control over empirical events that may be exercised by the investor are defined and evaluated. An investor's perceptual system is the medium with which the phenomena of the environment are noticed and registered in accordance with the network of concepts that governs the investor's perceptual processes.

The article discusses the idea of an accounting court which will establish authoritative accounting principles and which may tend to demonstrate errors in reasoning. An accounting court is a dubious method of arriving at an acceptable principle, since there are no laws which are to be used as a guide, no method of appealing any verdict, nor any means of changing laws to obtain equity. Since the professed purpose of the court is one of establishing principle it would seem that its function would be more legislative than judicial. The objective of disclosing errors in reasoning is admirable, but when differences in opinions are due to value judgments as to the credibility of a particular reason and, therefore, the probabilities of an assumption, the objective may be impossible to achieve. What might prove useful for the best value judgment of all accountants is an extensive compilation and critical analysis of reasons that have been advanced through the years for the basic assumptions of accounting.