Capital Asset Pricing Theory Research Articles

INVESTMENT DECISIONS UNDER UNCERTAINTY: APPLICATION OF ESTIMATION RISK IN THE HILLIER APPROACH

In a seminal paper in 1963, Frederick S. Hillier alerted the finance community to the importance of including probabi1istic information in the process of investment decision-making [4]. The method proposed and demonstrated by Hillier introduced the use of additional information regarding the probability distributions governing three measures of investment merit: present worth; internal rate of return; and uniform annual cost. He showed that by assessing investment merit only on the basis of a measure of central tendency, crucial information regarding dispersion, hence risk, was ignored and investments were not evaluated accurately. By incorporating the amount of risk involved in terms of the probability distribution of the present worth, the internal rate of return, or uniform annual cost, a firm's management can make more sound decisions regarding risky investment proposals. Since this important paper was published, a virtual revolution has occurred in finance, particularly in the area of risk assessment. Indeed, under modern capital asset pricing theory, the dispersion in the probability distribution of future cash flows is an irrelevant statistic. Instead, as the theory goes, a pro? ject1 s systematic risk, as indexed by its beta, is the only relevant measure of risk. This disparity between modern capital asset pricing theory and the type of analysis that follows from the Hillier approach will be addressed in detail in Section III. We will show that under conditions in which dispersion is regarded as the relevant measure of risk, the Hillier approach provides a

The Theory of Capital Asset Pricing

A respectable theory which accounts for investor behaviour needs to start from a statement of investor objectives. The objective may be generally stated as the maximisation of utility (von Neumann & Morgenstern 1953), though of itself utility is difficult to measure. In order to operationalise the theory utility may be broken down into more readily measurable elements, risk and return. From an investor's point of view, it also becomes necessary to specify a scale whereon various combinations of risk and return may be compared. This latter exercise is a very personal one; indeed it may be unique to each investor. It is beyond the scope of this paper to follow this line of argument. Instead we shall concentrate on describing the measurement of risk and return, in particular by using the Capital Asset Pricing Model (CAPM). We recognise, however, that in using this model, we are simplifying the investment behaviour process, in particular we posit the choice of portfolios to be based on single period return/risk with investors having identical estimates (subjective) of these returns.

Personal Taxes and Equity Security Pricing

* Do personal taxes affect pricing in the security markets? To a practitioner, the answer to this question is obvious: Yes. Yet, capital asset pricing theory is based on a number of perfect market assumptions one of which is that personal taxes do not exist. Equity prices are strictly a function of a security's beta and the expected market risk premium. Beta, the only company-specific estimate, is unlikely to capture any tax factors.

The Term Structure of Inflationary Expectations and Market Efficiency

FISHER'S [15] ORIGINAL FORMULATION OF an equilibrium relationship in which a nominal interest rate is equal to a real rate of interest plus the expected rate of inflation has stimulated considerable interest and research. Although many empirical studies have utilized a single equation distributed lag specification1 of past price changes (which might be induced from a rational expectations argument) as a proxy for expectations, T. F. Cargill and R. A. Meyer [5] have emphasized the necessity of a simultaneous equation structure if such distributed lags were to be employed. An alternative approach using Livingston's direct observations on expectations and allowing for the possibility of incomplete adjustment to expectations was employed by Cargill [2], W. Gibson [16] and D. Pyle [22]. These evolving improvements in conception of the empirical problem, data and econometric approach have led to a particularly interesting paper by K. Lahiri [18] in which S. Turnovsky's [25] expectations formation equations are coupled to the original Fisherian equation and then appropriate simultaneous equation techniques are applied to the resulting econometric relationships. From a slightly different perspective, E. Fama [13] has emphasized the implication for market efficiency embedded in the interest rate and expected inflation relationship. All analyses to date rest on the assumption that the real rate of interest is constant over time. Thus, as Fama noted, empirical implications for market efficiency tests really constitute a test of the joint hypothesis of efficiency and a constant rate.2 Despite the advances in conception of the empirical problem, data improvements, and improvements in econometric technique, the question of variation in the real rate of interest and the possibility of incomplete adjustment to changes in the real rate as well as to expected inflation leaves the extent and stability of the Fisherian relationship far from a settled matter. In addition, a much richer class of hypotheses emerges when Fama's emphasis on the market equilibrium aspects is carried further. No prior work has utilized any type of data to estimate the terni structure of expectations which is the key to Fisher's hypothesis when applied across maturities. In addition, the contributions of W. Sharpe [24] and J. Lintner [20] in providing an equilibrium capital asset pricing theory can be

Optimum control of stochastic differential equation systems

This paper is an exposition of the basic technique of optimal control for stochastic systems in continuous time and of several important economic applications. Sections 2 through 5 and 10 develop the technique in an elementary fashion. The remaining sections cover applications to consumption and portfolio selection over time, the theory of mutual funds and capital asset pricing, the pricing of stock options, and the optimum consumption and exploration of a limited natural resource.

Capital Asset Pricing: Theory, Empirics and Implications for Portfolio Management

This paper attempts to review briefly the current position of capital asset pricing theory and testing, and to consider the implications for portfolio managers. Inevitably in a paper of this length, it is not possible to include all the material that is relevant in such a large and important area, but most of the important matters have hopefully been covered.

The Inference of Tastes and Beliefs from Bond and Stock Market Data

In many circles the Mean Variance Capital Asset Pricing Model (MV CAPM) is synonymous with the theory of capital asset pricing. But in a single-period discrete-time model which explicitly recognizes the existence of limited liability the derivation of the MV CAPM, if it is to be consistent with the von Neumann-Morgenstern postulates of rational behavior, must be based on the assumption that all investors have quadratic utility functions. This assumption in turn implies that risky assets are inferior goods. However, if we turn to the broader class of linear risk tolerance (LRT) utility functions, for which the separation property holds, other simple two-mutual-fund CAPMs can be derived. The power utility LRT CAPMs are of particular interest as they are consistent with risky assets being normal goods.

COST OF CAPITAL FOR A DIVISION OF A FIRM: REPLY

The Journal of FinanceVolume 32, Issue 5 p. 1781-1782 Comment COST OF CAPITAL FOR A DIVISION OF A FIRM: REPLY Myron J. Gordon, Myron J. GordonSearch for more papers by this authorPaul J. Halpern, Paul J. HalpernFaculty of Management Studies, University of Toronto.Search for more papers by this author Myron J. Gordon, Myron J. GordonSearch for more papers by this authorPaul J. Halpern, Paul J. HalpernFaculty of Management Studies, University of Toronto.Search for more papers by this author First published: December 1977 https://doi.org/10.1111/j.1540-6261.1977.tb03374.x Read the full textAboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Share a linkShare onFacebookTwitterLinkedInRedditWechat No abstract is available for this article. Volume32, Issue5December 1977Pages 1781-1782 RelatedInformation

The Theorems of Modern Finance in a General Equilibrium Setting: Paradoxes Resolved

Looking back over the last two decades, financial economists can find considerable cause for pride and self-congratulation in the development of their discipline. From the earliest steps toward a rigorous theory of capital budgeting, through the Modigliani-Miller theorems on corporate financing and cost of capital, to the development of the capital asset pricing theory, the field of finance has garnered a well-deserved reputation for rigor, analytic sophistication, and pace of intellectual growth.

A PORTFOLIO THEORY OF THE SOCIAL DISCOUNT RATE AND THE PUBLIC DEBT*

FEW OF US have not at some time become intrigued with the relation between the social and the private discount rates. My interest in the subject was renewed by a series of papers by Arrow [1966], Hirschleifer [1966], Bailey and Jensen [1972], and others. These papers used state preference or capital asset pricing theory to deomonstrate that with perfect and complete capital markets the government is no more efficient than the capital markets as a means for diversifying away risk, and that the social and private discount rates are the same. Special circumstances may limit the effectiveness with which government or capital markets can be used to diversify away risk, and in such circumstances either the private or the social discount rate would be raised. Notwithstanding the apparent validity of this argument, I remained of the opinion that even with perfect and complete capital markets the social discount rate may be below the private rate. Therefore, I was confronted with the task of establishing what attributes of government the Arrow-Hirschleifer model of the problem failed to recognize. Those of you who are familiar with my previous work will find my conclusions here a predictable outcome of that work. I have for some time disputed the Modigliani-Miller theorem that a firm's cost of capital is independent of its leverage rate in the absence of taxes, or stated differently, that the corporate discount rate is the same as the private discount rate. Their theorem assumes personal leverage is a perfect substitute for corporate leverage while my position has been that this assumption is, in fact, not valid. The Arrow-Hirschleifer theorem requires, it seems to me, an even more untenable assumption-that personal leverage is a perfect substitute for government leverage. It would then follow that government is a legal fiction of no economic significance, that financial intermediation by government has no impact on the wealth and income of persons. However, this assumption ignores a unique property of government. It is the only debtor that can raise the funds required to meet its debts by printing money.1 Consideration of the possible advantages of financial intermediation by government on the micro level led me to the conclusion that as long as the government debt is small and inflation is not a problem, the social discount rate is well below the private discount rate. However, with analysis confined to the micro level, some questions must inevitably be left hanging which cast doubt on the validity of this conclusion. I therefore was forced to carry the inquiry forward to the macro level

THE EXPECTED HOLDING PERIOD RETURN, UNCERTAINTY AND THE TERM STRUCTURE OF INTEREST RATES

The Journal of FinanceVolume 30, Issue 2 p. 307-323 The Interest Rate Under Capital Asset Pricing Theory THE EXPECTED HOLDING PERIOD RETURN, UNCERTAINTY AND THE TERM STRUCTURE OF INTEREST RATES Ramon Johnson Johnson, Ramon Johnson Johnson Session ChairpersonUniversity of Utah.Search for more papers by this authorJohn S. McCallum, John S. McCallumUniversity of Utah.Search for more papers by this author Ramon Johnson Johnson, Ramon Johnson Johnson Session ChairpersonUniversity of Utah.Search for more papers by this authorJohn S. McCallum, John S. McCallumUniversity of Utah.Search for more papers by this author First published: May 1975 https://doi.org/10.1111/j.1540-6261.1975.tb01813.x Faculty of Administrative Studies, The University of Manitoba. The basis of this paper is the author's Ph.D. dissertation which was completed at the University of Toronto in 1973. In this regard, the author has benefited from the comments of Professors Jack Carr, Paul Halpern and Greg Jump and is particularly indebted to Professor Myron Gordon. Read the full textAboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Share a linkShare onFacebookTwitterLinked InRedditWechat Volume30, Issue2May 1975Pages 307-323 RelatedInformation

THE ELASTICITY OF FINANCIAL ASSETS

The Journal of FinanceVolume 29, Issue 4 p. 1229-1240 Article THE ELASTICITY OF FINANCIAL ASSETS Robert A. Haugen, Robert A. HaugenAssociate Professors, University of Wisconsin.Search for more papers by this authorDean W. Wichern, Dean W. WichernAssociate Professors, University of Wisconsin.Search for more papers by this author Robert A. Haugen, Robert A. HaugenAssociate Professors, University of Wisconsin.Search for more papers by this authorDean W. Wichern, Dean W. WichernAssociate Professors, University of Wisconsin.Search for more papers by this author First published: September 1974 https://doi.org/10.1111/j.1540-6261.1974.tb03100.xCitations: 20 Read the full textAboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Share a linkShare onFacebookTwitterLinked InRedditWechat Citing Literature Volume29, Issue4September 1974Pages 1229-1240 RelatedInformation

Mutual Fund Performance and the Theory of Capital Asset Pricing: Some Comments

IN TWO recent articles, William F. Sharpe has presented some results of a of a theory of capital asset pricing.' The purpose of this brief paper is to demonstrate that Sharpe's test is, in fact, no at all. Sharpe's theory of capital asset pricing can be summarized as follows: If we assume investors are risk averters with (1) similar expectations about the future performance of financial assets and (2) the ability to borrow and lend funds at a pure (riskless) interest rate, market prices of capital assets will adjust so that the predicted risk of each efficient portfolio's rate of return is linearly related to its predicted expected rate of return.2 Specifically, all efficient portfolios will lie along a line

Mutual Fund Performance and the Theory of Capital Asset Pricing]: Reply

Mutual Fund Performance and the Theory of Capital Asset Pricing]: Reply