Asset Selection Research Articles

Portfolio selection and matching: a synthesis

AbstractThis paper considers a general framework for the selection of assets to meet the liabilities of a life insurance or pension fund. This general framework contains the mean-variance efficient portfolios of modern portfolio theory as a special case. The paper also demonstrates how the portfolio selection and matching approach of Wise (1984a, 1984b, 1987a, 1987b) and Wilkie (1985) fits into this general framework. The matching portfolio is derived as a special case, and is also shown to have implications for determining the central value of the liabilities.

SELECTION OF ASSETS FOR A PROPERTY PORTFOLIO USING PORTFOLIO THEORY

To maintain and enhance the efficiency of a property portfolio the portfolio manager should select those property investment propositions which promise the maximum improvement of portfolio return and reduction of portfolio risk. To cope with this difficult task the portfolio manager needs appropriate decision criteria. This paper discusses some of the selection criteria evolved through the developments in capital market theory in order to assess their usefulness in property asset selection procedures. The use of the ‘reward‐to‐volatility’ criterion to select appropriate property portfolio projects is explored through a worked example. The reliability of such selection procedure depends on the availability of reliable historic record of the performance of the property market and of the property portfolio together with the portfolio manager's ability to perceive expected returns in different ‘states of the world’.

Cost Recovery Decisions for Asset Selection after ERTA and TEFRA

Cost Recovery Decisions for Asset Selection after ERTA and TEFRA

Review of: “CAPITAL BUDGETING: LONG-TERM ASSET SELECTION”by Jerome S. Osteryoung, Grid Publishing, Inc., Columbus, Ohio, 1979, XV + 356 pages, $18.95 list.

Review of: “CAPITAL BUDGETING: LONG-TERM ASSET SELECTION”by Jerome S. Osteryoung, Grid Publishing, Inc., Columbus, Ohio, 1979, XV + 356 pages, $18.95 list.

Venture Capital Management: A Survey of Attitudes towards Selection Criteria

In the literature, a number of factors such as high risk, high expected return, the lack of alternate traditional sources of capital and other non-financial factors (e.g., management) have been identified as being important in the evaluation of venture capital proposals. The major objective of this paper was to determine primarily through a questionnaire survey how Canadian and U.S. venture capitalists implement these criteria in the evaluation of proposals (asset selection), Interesting results were obtained on the diversification and composition of portfolios held, on the selection criteria employed and on the riskiness, underlying physical security and duration of the investments evaluated.

Portfolio theory—A planning tool

Portfolio theory is a relatively new development in the area of asset selection and diversification. Nevertheless, many articles, books and dissertations have been written to elaborate on the original concepts to such an extent that portfolio theory is now accepted doctrine in the field of finance. Portfolio theory deals with the rules for the intelligent selection of assets under conditions of risk. In this respect it is similar to planning, part of which consists of examining alternative courses of future action. Most of the research concerning portfolio theory has been directed toward the securities markets. Therefore, some of the terminology is investment oriented. Nevertheless, the concepts developed in portfolio theory can be applied to decisions concerning investments or to decisions that are part of a corporate plan. Think of investing in a security as being analogous to investing in a subsidiary, division, or product line. This article explains the major features of portfolio theory with the hope that corporate decision makers will use portfolio theory as a planning tool.

A Utility Maximization Approach to Individual Bank Asset Selection

A Utility Maximization Approach to Individual Bank Asset Selection

The Derivation of Efficient Sets

In 1952, Harry M. Markowitz [6] described a theory on the selection of assets in forming a portfolio. Assuming asset returns are stochastic, his theory postulated that rational investors should select a portfolio from the set of all portfolios which offered minimum risk (measured by variance) for varying levels of expected return. This set was named the efficient set by Markowitz.

Valuation and Asset Selection Under Alternative Investment Opportunities

Valuation and Asset Selection Under Alternative Investment Opportunities

Valution and Asset Selection Under Alternative Investment Opportunities: Discussion

Valution and Asset Selection Under Alternative Investment Opportunities: Discussion

Book Reviews

Book reviews in this article: Working Capital Management Dileep R. Mehta. Financial Statement Analysis: A New Approach By Baruch Lev. Capital Budgeting: Long‐Term Asset Selection By Jerome S. Osteryoung. Financial Management: Analytical Techniques By Leonard T. Wright. Finance as a Dynamic Process By Edwin J. Elton and Martin J. The Wall Street Gang By Richard Ney. The Fight for Competitive Advantage By William E. Fruhan, Jr. Syndication Landmarks, Vols. I and II By Stephen E. Roulac. The Crisis in Keynesian Economics By Sir John Hicks.

General Model of Imperfect Capital Markets

Extant capital theory, (e.g. [6, 10, 13, 15, 18], wherein the equilibrium return on a financial asset is shown to be a linear function of the return on a broad economic indicator or market portfolio is an extraordinarily powerful construct. It, at once, has provided economists with a theoretical tool for studying investor behavior under uncertainty and has generated a multitude of testable hypotheses concerning the way securities markets actually work and how investors actually behave. However, several shortcomings of the theory are apparent. First, it cannot explain the holding of other popular financial assets, most notably real estate and life insurance. Second, it fails to explain why similar assets may be selling for different prices in different markets even after special restrictions and controls have been taken into account.1 Third, it is, as developed, not a completely appropriate tool for capital budgeting decisions for it provides little insight into the fact that individual firms do not hold fully diversified portfolios of real assets, and may, in fact, not want to hold such collections. The purpose of this paper is to develop a general structure within which the parameters of future research into the area of asset selection and investor behavior under uncertainty in the presence of segmented and/or otherwise imperfect markets can be placed. However, its focus is, without loss of generality, on the for securities. There is a more general explanation of the aforementioned exemplary shortcomings as well as others which can be identified by the reader. First, there are imperfections within

Application of Stochastic Dominance Principles to the Problem of Asset Selection Under Risk

Application of Stochastic Dominance Principles to the Problem of Asset Selection Under Risk

Risk, Return, and Equilibrium: A General Single-Period Theory of Asset Selection and Capital-Market Equilibrium.

Uncertainty is a major concern in financial decision-making. Financial theory contains a number of conceptual frameworks that treat the effects of uncertainty; yet no one has attempted to put forth a general treatment of portfolio risk. This book fills the theoretical gap by developing a general measure of portfolio risk and formulating a general model of asset selection in the context of market equilibrium. The author seeks to define and elucidate theoretical issues through rigorous, quantitative arguments; and critical evaluation of the basic assumptions of the model.Stone summarizes relevant aspects of the Markowitz theory of portfolio selection and presents a brief overview of the Sharpe, Lintner, and Mossin models in which asset selections are based on two parameters of choice--either mean return and variance, or mean return and standard deviation. He then generalizes these models to objective functions that are still functions of two parameters--expected return (or expected wealth), and a general measure of risk. Stone introduces a new global measure of risk, relating it to existing work in the theory of risk, and presents and compares two alternative risk-return representations of expected utility: the Generalized Markowitz Criterion (GMC) and the Two-Parameter Functional Representation (TPFR). The author provides a general analysis of asset selection and market equilibrium and examines the GMC and TPFR in greater detail. Finally, he investigates existing models of capital market equilibrium formulated by Sharpe, Lintner, and Mossin, and analyzes these models according to the previously developed general model.Mathematical analysis and logical reasoning are the basic methodological tools used in this work. The author has, however, taken care to present proofs and derivations in sufficient detail to make them easy to follow at a graduate level. Students of economics and finance (particularly those in advanced courses dealing with risk, asset selection, or capital markets) and professionals in the field will find the book rich in constructive new theoretical material.

BOOK REVIEWS

Book reviewed in this article:Aggregate Theory and Policy; Monetary Economics—Readings on Current Issues. By William Gibson and George Kaufman.Monetary Theory: Inflation, Interest, and Growth in the World Economy. By Robert A. Mundell.Business Finance and Investments; Utility Regulation During Inflation. Edited by Joseph E. Haring and Joseph F. Humphrey.Financial Management of Foreign Exchange. By Bernard A. Lietaer.The Corporate Economy. Robin Marris and Adrian Wood, Eds.Cash Management and the Demand for Money. By Daniel Orr.Risk, Return, and Equilibrium: A General Single‐Period Theory of Asset Selection and Capital‐Market Equilibrium. By Bernell K. Stone.Financial Institutions and Markets; Credit Rationing and the Commercial Loan Market. By Dwight M. Jaffee.A History of Financial Intermediaries. By Herman E. Krooss and Martin R. Blyn.International Finance; Canada's Experience with Fixed and Flexible Exchange Rates in a North American Capital Market. By Robert M. Dunn. Jr.Capital Transfers and Economic Policy: Canada, 1951–1962. By Richard E. Caves and Grant L. Reuber with Robert W. Baguley, John M. Curtis, Raymond Lubitz.Public Finance; Indirect Taxation in Developing Countries. By John F. Due.Tax Incentives and Capital Spending. Edited with commentary by Gary Fromm.Modern Public Finance: The Study of Public Sector Economics. Second Edition. By Bernard P. Herber.State and Local Finance. Edited by William E. Mitchell and Ingo Walter.

THE DEMAND FUNCTIONS OF THE HOUSEHOLD SECTOR FOR FINANCIAL ASSETS: AN ECONOMETRIC STUDY*

THIS STUDY investigates the demand functions of the household sector for financial assets, on both theoretical and empirical levels. A model of asset selection is presented for an individual household, then is aggregated to represent the entire household sector. This model is an outgrowth of work performed by Farrar and de Leeuw and is based on the efficient portfolio theory of Markowitz and Tobin. The hypothetical household of the model faces an array of possible financial assets and liabilities it can choose among, thereby receiving an expected return and incurring a level of risk exposure. The household's utility function is given a quadratic approximation and is maximized subject to a net wealth constraint. From this maximization is derived a generalized demand function linear in net wealth and rates of return. The model is then altered to produce a submodel in which the resultant demand functions are homogeneous of degree one in net wealth. Demand functions are estimated for seven financial assets in addition to gross financial assets. Two different specifications of the generalized demand function are employed. The first uses aggregate net wealth as the constraint on the household sector. In the second the aggregate net wealth constraint is divided into two parts, deflated net wealth and capital gains on financial assets. The latter is designed to capture the differential effects of various subclasses of net wealth upon the financial asset demand functions of the household sector. Estimation is based on a sample of 57 quarterly observations of the household sector, first quarter, 1952, through first quarter, 1966. The major conclusions of this study are as follows: (1) Aggregate net wealth is an important determinant of households' financial asset demands. While there is some evidence of a lagged response in the adjustment of households' financial asset stocks to changes in net wealth, the same evidence indicates that this lag seldom has any importance when extended beyond four quarters. (2) Disaggregation of the net wealth argument into two separate arguments, consisting of deflated wealth and capital gains on financial assets, results in the deflated wealth argument behaving in a fashion similar to net wealth. Deflated wealth proves to be an important influence upon the financial asset demands of households. (3) The capital gains argument used when net wealth is disaggregated does not possess great explanatory power and as a result only short lags in adjustment are discovered with reference to changes in the capital gains type of wealth. The signs of the coefficients of the capital gains argument are frequently negative in the current period and/or when the lag is short. This evidence is consistent with, but fails to demonstrate firmly, the contention that the receipt of a capital gain stimulates households to increase their consumption in the very short-run and perhaps temporarily to draw down on certain financial asset stocks.

A Model for Selecting Commercial Bank Government Security Portfolios

T HE object of this paper is to formulate a normative model for selecting a bank's Government security portfolio. Two major problems arise in constructing a model of bank portfolio selection. First, the model must handle uncertainty. This includes not only uncertain future events but also the decision maker's preferences for the outcomes associated with these events. Second, it must recognize the intertemporal or multi-period character of the decision making process. This means that a decision made in one period will influence subsequent decisions and hence, that subsequent decisions must be considered in arriving at the present one. The present paper applies Bayesian and sequential decision theory to handle both the expectationally stochastic and the dynamic aspects of this important decision problem simultaneously and consistently. No previous model of commercial bank portfolio selection handles either or both problems satisfactorily. Porter's model of bank asset selection recognizes uncertainty by treating future cash flows and security prices as random variables, but it is only one period in length. Moreover, it does not consider the decision maker's preferences.' Since the objective function is linear, the model produces a portfolio diversified between securities and loans only through the selection of distribution functions describing the random variables. These transform the function into a nonlinear one upon integration. Cheng's model of bank security portfolio selection is, in effect, a one period formulation also.2 It incorporates uncertainty and the decision maker's preferences through Markowitz's efficient portfolio concept.3 An efficient portfolio is one which maximizes expected return for a given variance of return (or minimizes the variance of return for a given expected return). As Tobin points out, however, this criterion assumes, quite restrictively, that either the variable return is normally distributed or that the decision maker has a quadratic utility function.4 Cheng also makes the highly unrealistic assumption that securities are held to maturity. Multi-period bank portfolio selection models are all based on the assumption that future events are known with certainty. One such model formulated by Chambers and Charnes attempts to reflect the risk inherent in different portfolio configurations by including the Federal Reserve's capital adequacy formula as a constraint.5 Used in the supervision of banks, the capital adequacy formula allocates a bank's capital to designated asset categories on a fractional basis. The values of the fractions are designed to measure the percent by which the different asset categories would decline in market value if they had to be liquidated quickly.6 The choice of these values is somewhat arbitrary. Moreover, the formula itself implicitly assumes a particular preference structure and a certain probabilistic occurrence of future events. Neither assumption is likely to represent accurately either the decision maker's preferences or expectations.7

Earnings Probabilities and Capital Costs

M ODIGLANI and Miller' have contended that a firm's over-all capital cost is invariant with respect to financial structure, in a taxfree environment. Where corporate income taxes exist, and where payments to creditors are tax deductible, the association of low capital costs with high debt financial structures logically follows the M-M thesis. In a competitive environment, a quest for low costs, including low capital costs, is necessary for survival. The predominance of moderate debt financial structures in the United States, where both high corporate taxes and competition also prevail, suggests that Modigliani and Miller have not provided an accurate predictive hypothesis. In this paper, I will examine two of the arguments that have been associated with the M-M controversy-the imperfect market explanation for financial structure optimums, and Solomon's observation that, for the M-M hypothesis to hold, cost of debt increases must be accompanied by declines in the marginal cost of equity. The explanation advanced on Solomon's point rests on a consideration of the effect of capital structure on earnings probability distributions. Further examination of this effect leads me to propose a new hypothesis to explain capital structure usage. This hypothesis holds that a high proportion of debt biases the firm toward the selection of assets with high business risk, and then that, since business risk is a function of capital structure, so also is capital cost.

Firm Size and Rate of Growth

Firm Size and Rate of Growth