Individual Portfolios Research Articles

GROUP EFFECTS AND BETA NONSTATIONARITY

Recent evidence indicates that while random diversification can lead to the elimination of the majority of systematic risk, the systematic selection of securities can result in significant group effects blocking this dissipation of unsystematic risk. The group effects associated with investment in growth, cyclical, stable and oil stocks found by Farrell and Martin and Klemkosky were reexamined while allowing for beta nonstationarity. It was found that the beta nonstationarity effect, while quite large for individual stocks and small portfolios tended diversify away quite quickly. It was further found that much of what has in the past been termed a group effect is actually the result of beta nonstationarity.

The Interdependence of Individual Portfolio Decisions and the Demand for Insurance

We analyze the individual's demand for insurance as a special case of general portfolio hedging activity. The demand for insurance contracts is determined simultaneously with the demands for other assets in the portfolio. We demonstrate that when the payoffs of the policy are correlated with the payoffs to the individual's other assets, the demand for insurance contracts is generally not a separable portfolio decision. We argue that this separability condition is not generally met because of significant interdependence of claims across different insurance policies. Furthermore, our generalizations can reverse the standard prediction that wealthier individuals will demand less insurance.

Miller's Equilibrium, Shareholder Leverage Clienteles, and Optimal Capital Structure

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 (e.g., [8], [2], [3], [14], [13], [6], [7], [1], [9], [19], [20], [21], [23]). 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 [14]. 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 (e.g., [4], [6], [7], [13], [19], [20]).

Some Stronger Measures of Risk Aversion in the Small and the Large with Applications

THE ARROW-PRATT MEASURES of risk aversion for von Neumann-Morgenstern utility functions have become workhorses for analyzing problems in the microeconomics of uncertainty. They have been used to characterize the qualitative properties of demand in insurance and asset markets, to examine the properties of risk taking in taxation models, and to study the interaction between risk and life-cycle savings problems to name just a few applications. Equally importantly, they have generated the linear risk tolerance class of utility functions which has provided canonical examples in such diverse areas as portfolio theory and the theory of teams. Despite these successes, there have been a number of areas for which the results have been weaker than hoped. It is natural to use the risk aversion measures to compare the behavior of individuals in risky choice situations. For example, consider the individual portfolio choice problem in a two asset world with a riskless asset and a risky asset. If individual A has a uniformly higher Arrow-Pratt coefficient of risk aversion than individual B, then B will always choose a portfolio combination with more wealth invested in the risky asset. But, suppose that both assets are risky. Now, there is no obvious sense in which the more risk averse individual can be said to hold a less risky portfolio, but it seems strange that such a simple alteration should destroy the analytics which support the basic intuition. Similarly, consider the basic insurance problem. If one individual, A, is more risk averse than another, B, in the Arrow-Pratt sense, it follows that A will pay a larger premium to insure against a random loss than will B. Typically, though, an individual evaluates partial rather than total insurance, that is, only some gambles can be insured against and others must be retained. In this case, even when the gambles which are retained are independent from those which are insured, it is no longer true that the individual whose Arrow-Pratt measure of risk aversion is higher will pay a larger insurance premium. The situation is no better when we consider comparative statics exercises for a single individual. Decreasing absolute risk aversion in the sense of Arrow and

Private Sector Expenditure and Financial Asset Accumulation in the U.K.

THE GROWING TENDENCY in economic theory is to analyze macroeconomic problems in the context of portfolio choice, with the most notable work in this field being that of Brainard and Tobin [2], and Tobin [12]. Typically portfolio decisions are assumed independent of spending decisions regarding the scale of activity. The homogeneity of portfolio behavior with respect to wealth, combined with appropriate balance sheet identities, implies a series of adding up conditions that need to be fulfilled when constructing individual portfolio equations. In this paper we propose an alternative approach to investment decisions including decisions regarding consumer durables and inventories. We argue that financial and commodity assets are considered part of the same portfolio decision, where closely related assets are nested so as to represent a multilevel sequential decision-making process. We regard households as deciding primarily about scales of assets size of house, of family, of cars, of heating, etc. and secondarily being involved in a consequent maintenance decision (nondurable consumption) running the house, feeding the family, servicing the car, etc. In the case of firms, we see them as deciding on a scale of physical assets in combination with a financial assets liability, and this involves a maintenance decision (or capital consumption). This amounts to putting the portfolio's composition in the center of

A Model of International Trade and Finance

An equilibrium model of international trade, payments, and financial asset flows is developed with implications for the relationship between asset returns and changes in the relative prices of consumption goods of different countries. The model focuses on international trade as enlarging the opportunity for intertemporal exchange. The main source of uncertainty in the model is revisions of investors' expectations of the profitability of country-specific capital. The model is extended to include money to demonstrate how international monetary agreements may affect individual portfolio decisions.

An Analysis of the Forecast Error Impact of Alternative Beta Adjustment Techniques and Risk Classes

THE PURPOSE OF THIS paper is to examine empirically the relationships among the stability of security and portfolio betas and (1) beta adjustment techniques, (2) beta risk classes, and (3) the length of the sample periods used to calculate betas. The beta coefficient of the familiar market model has emerged in recent years as an important tool for assessing the risk associated with individual securities and portfolios. The usefulness of an ex post beta for measuring the ex ante risk of an investment depends, however, upon the temporal stability of the asset's beta coefficient. While there have been numerous studies concerned with an empirical examination of beta stability [1, 2, 3, 6, 7, 8, 10], there has been no examination of forecast error components associated with different beta groups classified according to beta magnitude or with different beta estimation and prediction period lengths.' Typically, studies have used a single length beta estimation and prediction period [2, 3, 5, 6, 7], and if the lengths of the beta estimation and prediction periods were varied, the two period lengths were always equal for each comparison [1, 8]. Alternative estimation and prediction period lengths are used in this study to examine the impact of beta adjustment techniques, risk classes, and portfolio size on the beta forecast error and its components. The results of this study indicate that beta forecast errors may be substantially reduced when (1) beta adjustment procedures are utilized, (2) portfolio size is increased, and (3) the estimation or prediction period is increased. When securities or portfolios are grouped into risk classes, adjustment techniques are very effective in reducing the size of the inefficiency and bias components of the forecast error, but they show little impact on the random error components. Furthermore, for more extreme risk classes, the primary source of error is bias for portfolios when no adjustments are made, while random error is the major source of forecast error for single securities for longer estimation periods.

Capital Asset Pricing in a General Equilibrium Framework

The striking and powerful conclusions of the capital asset pricing model (CAPM) [13,8] arise from imposing the requirement that optimal individual portfolio decisions must be consistent with a market equilibrium for securities. That simple requirement–of market balance–produces the strong results that have been the centerpiece of research in finance in the last fifteen years. But despite the huge payoffs to imposing equilibrium requirements on financial markets, the CAP model remains a partial equilibrium result. The risks which are attributed to securities are strictly exogenous. Securities are risky because their prices fluctuate, but the cause of those price fluctuations is rarely specified. The literature seems to associate “market risk” with the business cycle and individual security risk with either random technological change or demand uncertainty. But whatever attribution is made, such risk remains outside of the model itself. Since the keystone of the CAPM is its important distinction between “real” or nondiversifiable risk and purely financial uncertainty, it is disconcerting to recognize that it is a model in which real quantities do not appear at all.

RECENT DEVELOPMENTS IN THE COST OF DEBT CAPITAL

THE IRRELEVANCE OF financial policy was first noted by J. B. Williams [46] some forty years ago, as he stated that no change in the investment value of the enterprise as a whole would result from a change in its capitalization.' In 1952, Durand [9], in contrasting the Net Operating Income and the Net Income approaches to market valuation, demonstrated that the value of a firm is independent of its capital structure under the Net Operating Income theory of market valuation. However, it was not until after the publication of Modigliani and Miller's (MM) [31] classic paper in 1958 that the theory of financial leverage began to attract a great deal of attention among researchers in finance and economics. In their paper, Modigliani and Miller first brought out more explicitly the relationship between market valuation and individual portfolio decisions under uncertainty and proved, based upon the risk-class assumption and the arbitrage argument, the famous proposition that the value of a firm is invariant to its capital structure in the absence of corporate income taxes and bankruptcy risk. Several subsequent studies have shown that the same result can be obtained under more general conditions.2 The meaning and the measure of a firm's cost of capital have been the subject of numerous theoretical and empirical inquiries in the past two decades, and the theory of financial leverage has now become an essential part of the modern theory of corporation finance. The cost of debt capital, an integral part of a firm's cost of capital, is defined as the equilibrium required rate of return on a risky corporate bond. Therefore, understanding the theory of corporate bankruptcy and the pricing of risky debt in an equilibrium capital market is the key to a better understanding of the determinants of a firm's cost of debt capital. The purpose of this paper is to review some recent developments in the theory of pricing risky debt and to examine more systematically the determinants of the cost of debt capital. In Section II, we review and discuss the pricing of risky bonds and the determination of the cost of debt capital within a framework of one-period capital asset pricing model under uncertainty. In Section III, the mathematically more elegant models of pricing risky bonds based upon the continuous-time option pricing model are reviewed and discussed. The determinants of the risk premiums

The Impact of Race and other Variables on the Composition and Value of Individual Portfolios

This study indicates that socio-economic variables play an important role in the determination of portfolio allocation and the value of assets in the portfolio. However, it should be noted that these factors are not sole determinants. Relevant variables, such as expectations and attitudes, have not been considered here, although where other variables have been studied, no definitive results were stated.15 Importantly, race is a significant determinant of portfolio diversity but not of the value of assets in the portfolio. Therefore, it does make a difference in portfolio composition whether an individual is black or white, but if the individual maintains a diversified portfolio, race becomes immaterial.

THE ASSET STRUCTURE OF INDIVIDUAL PORTFOLIOS AND SOME IMPLICATIONS FOR UTILITY FUNCTIONS

The Journal of FinanceVolume 30, Issue 2 p. 585-603 The Allocation of Wealth to Risky Assets THE ASSET STRUCTURE OF INDIVIDUAL PORTFOLIOS AND SOME IMPLICATIONS FOR UTILITY FUNCTIONS James C. Van Horne, James C. Van Horne Session ChairpersonStanford University.Search for more papers by this authorMarshall E. Blume, Marshall E. Blume ProfessorThe authors are respectively Professor of Finance and Richard K. Mellon Professor of Finance and Economics at the Wharton School, University of Pennsylvania. We wish to acknowledge the financial support of the Rodney L. White Center for Financial Research.Search for more papers by this authorIrwin Friend, Irwin Friend ProfessorThe authors are respectively Professor of Finance and Richard K. Mellon Professor of Finance and Economics at the Wharton School, University of Pennsylvania. We wish to acknowledge the financial support of the Rodney L. White Center for Financial Research.Search for more papers by this author James C. Van Horne, James C. Van Horne Session ChairpersonStanford University.Search for more papers by this authorMarshall E. Blume, Marshall E. Blume ProfessorThe authors are respectively Professor of Finance and Richard K. Mellon Professor of Finance and Economics at the Wharton School, University of Pennsylvania. We wish to acknowledge the financial support of the Rodney L. White Center for Financial Research.Search for more papers by this authorIrwin Friend, Irwin Friend ProfessorThe authors are respectively Professor of Finance and Richard K. Mellon Professor of Finance and Economics at the Wharton School, University of Pennsylvania. We wish to acknowledge the financial support of the Rodney L. White Center for Financial Research.Search for more papers by this author First published: May 1975 https://doi.org/10.1111/j.1540-6261.1975.tb01833.xCitations: 19 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 Volume30, Issue2May 1975Pages 585-603 RelatedInformation

The Asset Structure of Individual Portfolios and Some Implications for Utility Functions

The Asset Structure of Individual Portfolios and Some Implications for Utility Functions

Determining the Construction and Composition of an Individual Securities Portfolio

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