Risk-free Return Research Articles

Evidence of Implicit Taxes on Equity Using Data from Futures Markets to Control for Risk

In this paper we investigate the existence and magnitudes of implicit taxes on equity. Specifically, using futures market data to control for risk, we test whether the pre-tax returns on bonds are higher than the pre-tax returns on four stock indices during the period 1993-1999. We compare the risk-free stock index returns (on perfectly hedged portfolios) to risk-free returns on taxable bonds, and estimate implicit taxes on equity. We find a moderate but significantly positive implicit tax for each stock index. Moreover, we find that cross-sectionally, implicit taxes are much larger for the low-dividend NASDAQ 100 than for the other three, substantially higher dividend-yielding indices. We also find that estimated implicit taxes have fallen significantly during the sample period. Our findings are consistent with a multiple clientele explanation, in which more than one tax clientele is the marginal investor in the stock market.

Price differentials between different classes of stocks: an empirical study on Chinese stock markets

This paper investigates the effect of strict segmentation on pricing in the context of the Chinese stock markets. The paper demonstrates that information asymmetry between foreign investors and domestic investors, liquidity effects, diversification effects, clientele bias, risk-free return differentials between foreign and domestic investors, and foreign exchange risks are significant factors in explaining discounts on shares that can only be owned by foreign investors.

An introduction to security returns

The equity premium - the difference between the return achievable from investment in the equity market (RM ) and the risk-free rate of return (RF )- plays an important part in corporate finance. The expression equity premium (sometimes referred to as the equity risk premium) is used to denote the ex ante expectation of investors. The term excess return refers to the ex post achievement of stock returns over and above the risk-free return. If we compare US and UK returns, we find that total returns, real returns and the value of (RM - RF ) are all marginally higher for the UK. Summarized evidence appears in Table 1 and Table 6. Such greater returns may be due to an increased risk premium related to increasing unexpected inflation. Particularly important in estimating the equity risk premium is whether excess returns are measured using a geometric or an arithmetic mean return. To a significant extent, this question revolves around mean reversion in stock returns. Evidence of mean reversion is substantial, although it cannot be proved unequivocally. Given the weight of evidence of mean reversion, there may be a strong case for the use of a geometric mean with an equity premium of between 3% and 5% - or even less.

Revisiting the Basics of Return and Risk in Equilibrium

Consider the following two well-diversified portfolios: The first consists of 100 preferred stocks and the second of 100 regular equity stocks. Which of the two portfolios is riskier? Common sense would seem to suggest that the equity portfolio is more risky. In terms of traditional concepts it may well be that the equity portfolio has a larger beta, but the major reason for the suggested answer rests arguably more on the idea that the distributional spread of the equity portfolio exceeds the one of preferred stocks. That is, the equity portfolio return distribution has greater upside potential as well as downside risk. Despite the intuitive appeal of this idea, a problem arises from a traditional perspective since the upside/downside concept makes no reference to how the returns' distributions relate to factors influencing the broader opportunity set (e.g., the return on the market portfolio). Hence, to capture the texture of the proposed answer in a formal analysis requires assumptions which to a significant degree eliminate equilibrium features embraced by CAPM and APT. This paper develops an equilibrium model that differs materially from CAPM/APT type of theories concerning risk and return. The focus is on excess returns, i.e., returns minus the (spot) risk-free return, and the setting specified implies the following approximation in equilibrium: A constant gamma exists such that the excess return of portfolio one has the same distribution as that of portfolio two scaled by gamma. In other words, the two distributions of excess returns are the same, except for their scales. One can think of gamma as a relative (inverse) risk index; it exceeds 1 if and only if portfolio one is less risky than portfolio two. Because this concept of risk does not require perfectly dependent returns, the model here has unique features which CAPM or APT settings obviously lack. One can describe the above equilibrium property more intuitively. Consider the possibility of combining borrowing or lending with an investment in either of the two portfolios. Suppose there exists some mix of borrowing and a long position in the preferred stock portfolio so that the implied leveraged portfolio return distribution replicates the distribution of the equity portfolio return. If this is true, then the two excess return distributions are equivalent aside from the two distributions' connecting scale factor. The notion of relative risk in this scenario makes sense intuitively since it relates to whether borrowing or lending is necessary to equate the two portfolios' distributions. The set-up is a simple one-period model with no significant restrictions on preferences, except that more-is-better-than-less. Issues surrounding the modeling of the joint distribution of returns are more delicate. In broad terms, the return specification satisfies a one-factor model. It differs from the prototype model in two respects. First, the (random) commonality factor is always positive (rather than mean zero as is usually the case). Second, the factor model has a random response-coefficient. This crucial feature implies that the returns' distributions cannot be perfectly dependent. An equilibrium will therefore derive from portfolio optimization rather than a pure no-arbitrage argument. Further, an assumption on the slope-coefficients' distribution works such that any weighted average of slope-efficients will approximately have the same type of distribution. It follows that any portfolio combined with borrowing/lending can approximately replicate any other portfolio's return distribution. One can also derive the desired equilibrium in an approximate sense.

Asset pricing in production economies

This paper studies asset returns in different versions of the one-sector real business cycle model. We show that a model with habit formation preferences and capital adjustment costs can explain the historical equity premium and the average risk-free return while replicating the salient business cycle properties. The paper also applies a solution technique that combines loglinear methods with lognormal asset pricing formulae.

The Benchmark Error Problem with Global Capital Markets

the University of Notre Dame at the time h s article was written. D uring the late 1970s and early 1980s, Richard Roll in several articles voiced concern with the testing of the Capital Asset Pricing Model (CAPM), as well as with use of the model to evaluate investment performance (Roll [1977, 1978, 1980, 19811). Roll referred to t h s latter problem as a benchmark error, because the practice has been to compare the performance of a portfolio manager to the performance of an unmanaged portfolio of equal risk. The benchmark typically has been a security market index adjusted for risk, where the risk measure is the one implied by the CAPM (i.e., beta). Roll shows that if the benchmark employed in this evaluation is mistakenly specified, you cannot measure the performance of portfolio managers properly. An inappropriate proxy for the market portfolio (benchmark) can have two effects. First, the systematic risk measures (beta) computed for individual assets and for alternative portfolios will be wrong, because the betas are derived using an inappropriate proxy for the market portfolio. Second, the security market line (SML) derived to measure the relative risk-adjusted performance of alternative portfolios d be misspecitied because the SML. is then the line h m the risk-free return through an improperly specified proxy for the market portfolio. Roll shows that, assuming the proxy used to represent the market portfolio of risky assets is not as mean-variance efficient as the “true” market portfolio, it is possible that the performance of a portfolio using the inappropriate SML would be considered superior,

Growth-Security Investment Strategy for Long and Short Runs

It is well known that the investment policy maximizing the expected logarithm of wealth each period is a long-run optimal capital growth criterion. However, the growth-optimal strategy entails a considerable risk of losing a substantial portion of wealth for the investment in the short run. This paper extends the long-run capital growth criterion to a multiperiod investment policy which maximizes the capital growth and at the same time achieves a given probability of maintaining an accumulated risk-free return over any finite investment horizon.

Henry George and an Alternative Islamic Land Tenure System

banking, a result of the much discussed Islamic resurgence, is probably the most significant part of an attempt to instill an ethos into a socioeconomic system. Although much can be said about the sincerity and the success of such social engineering, here I intend to examine only the wider economic application of profit-and-loss sharing, a novel feature in the theory of banking. Essentially, banking is based on equity participation because law prohibits an agent from earning a return without incurring a risk attached to a productive activity or engaging in some form of socially productive effort.1 Such a return is referred to as riba, and transactions that entail such exchange are referred to as ribawi. Since interest is interpreted by most Muslim scholars as constituting a predetermined and hence risk-free return, it is considered ribawi. The two main financial instruments in banking, borrowed from the writings of medieval jurists, are essentially forms of equity participation. In mudaraba, entrepreneurs use borrowed funds in a productive enterprise and share profits, if any, according to a prespecified ratio with the lenders. Any loss that is not caused by negligence is borne by the lenders. Musharika differs only in that the entrepreneur's capital investment is drawn partly from his own funds rather than entirely from borrowed funds.2 This form of equity participation, generally referred to as profitand-loss sharing (PLS), has been suggested as a land tenure arrangement by various classical and recent scholars.3 This recommendation has been made because the conventional contracts, sharecropping and renting, have been the subject of continual controversy.4 Although this article may appear to be addressing an impractical issue, the Council of Ideology in Pakistan has endorsed the use

The equity risk premium a solution

In ‘The Equity Risk Premium: A Puzzle’, Mehra and Prescott (1985) developed an Arrow-Debreau asset pricing model. They rejected it because it could not explain high enough equity risk premia. They concluded that only non-Arrow-Debreu models would solve this ‘puzzle’. Here, I re-specify their model, capturing the effects of possible, though unlikely, market crashes. While maintaining their model's attractive features, this allows it to explain high equity risk premia and low risk-free returns. It does so with reasonable degrees of time preference and risk aversion, provided the crashes are plausibly severe and not too improbable.

Les prêts internationaux dans l’entre-deux-guerres : le point de vue des porteurs de titres

This paper revises and extends our previous (1986) analysis of rates of return on sterling and dollar foreign loans on the 1920s. It analyses a larger sample of 250 dollar bonds and 125 sterling issues, covering the years 1920-1929. Internal rates of return adjusted for repurchases of discounted foreign bonds. The larger sample confirms the main conclusions of our original study and enables us to paint a richer picture of interwar experience with foreign loans. We also analyse déterminants of ex ante spreads on foreign loans relative to risk-free returns, and assess the sophistication of investors.

A note: Debunking the myth of the risk‐free return

A note: Debunking the myth of the risk‐free return

Stock Index Futures: Does the Tail Wag the Dog?

(1987). Stock Index Futures: Does the Tail Wag the Dog? Financial Analysts Journal: Vol. 43, No. 2, pp. 57-61.

Valuing Pensions (Annuities) with Different Types of Inflation Protection in Total Compensation Comparisons: A Note

Valuing Pensions (Annuities) with Different Types of Inflation Protection in Total Compensation Comparisons: A Note

The equity premium: A puzzle

Restrictions that a class of general equilibrium models place upon the average returns of equity and Treasury bills are found to be strongly violated by the U.S. data in the 1889–1978 period. This result is robust to model specification and measurement problems. We conclude that, most likely, an equilibrium model which is not an Arrow-Debreu economy will be the one that simultaneously rationalizes both historically observed large average equity return and the small average risk-free return.

Divergent Rates, Financial Restrictions and Relative Prices in Capital Market Equilibrium

The mean-variance capital asset pricing model (CAPM) of Sharpe and Lintner was extended by Brennan [3] to incorporate divergent borrowing and lending rates. He found that in equilibrium the security market line (SML) has the same structure as the SML under the single-rate CAPM of Sharpe and Lintner. That is, the expected return of a security or a portfolio remains linear in its systematic risk, with the intercept replaced by an equivalent risk-free return, which is an average of the divergent borrowing and lending rates weighted by the investors' taste parameters. The equivalent risk-free return is larger than the riskless lending rate and, hence, does not represent an inconsistency with the empirical findings by Friend and Blume [4] and by Black, Jensen and Scholes [1[ that the intercept of empirical SML estimated for the single-rate CAPM is larger than the riskless rate. Moreover, Brennan attempted to show that his construct can be extended to the extreme case where there are no riskless opportunities. The case of no riskless opportunities was of course investigated by Black [2], who generalized the CAPM and SML by inventing the concept of zero-beta port-folio to account for the same empirical problem encountered in the traditional SML tests of CAPM. Since the Sharpe-Lintner single-riskless-rate CAPM implies a perfect loan market, we may view the attempts by Black and Brennan as generalizing the CAPM by incorporating financial restrictions and loan market imperfections. Their primary motive, however, is empirical, i.e., to reconcile the results from the traditional SML tests with their generalized CAPM.

MODIFIKASI MODEL INDEKS JANSEN SEBAGAI ALAT UKUR KINERJA SAHAM SYARIAH

The Jansen Index is a measure of stock performance based on the Capital Asset Princing Model (CAPM). The Jansen Index consists of 4 (four) components, namely: stock returns, beta stocks, market returns, and risk-free returns. Many studies approach risk-free returns with interest rates when measuring the performance of Islamic stocks in the Jansen Index model, while interest rates are prohibited in the concept of Islamic finance. This paper discusses the modification of the Jansen Index model to analyze the performance of Islamic stocks with 4 (four) approaches, namely the model without interest rates, models with zakat rates, models with inflation, and models with gross domestic production (GDP) and compare them with models with interest rates (BI-Rate). Then the five models are implemented in the Islamic capital market in Indonesia in the period January 2011 - July 2018.The results obtained are that there is a very high suitability for the measurement results of the five models. Judging from the closeness of the results of performance measurement, the five models can be grouped into 2 (two), namely models with interest rates, inflation, and GDP as the first group, while models without interest rates and zakat- rate as the second group. This means, on the concept of Islamic finance, risk-free returns can be measured using these 4 (four) approaches, specifically inflation or GDP

Risk, The Pricing of Capital Assets, and The Evaluation of Investment Portfolios

THE MAIN PURPOSE of this study is to develop a model for evaluating the of portfolios of risky assets. The model begins from the Sharpe-Lintner theory of capital-asset prices, but allows explicitly for the effects of differential degrees of risk on the returns of portfolios-a problem which has never been satisfactorily solved. The Sharpe-Lintner results (originally detived in the context of a singleperiod model under the assumption of identical investor horizons) are extended to a multi-period world. In this model investors' horizons may be of different lengths and assets may be traded continuously. In addition, the Sharpe-Lintner ex ante model is extended to include ex post relationships. The resulting model expresses the expected returns on a security (or portfolio) as a function of its level of the risk-free return, and the actual realized returns (instead of the expected future return) on the over any holding period. Given these results, a measure of portfolio performance (which measures only a manager's ability to forecast security prices) is defined as the difference between the actual returns on a portfolio in any particular holding period and the expected returns on that portfolio conditional on the riskless rate, its level of systematic risk, and the actual returns on the market portfolio. Criteria for judging a portfolio's to be neutral, superior, or inferior are established. A measure of a portfolio's efficiency is also derived, and criteria for judging a portfolio to be efficient, superefficient, or inefficient are defined. It is also shown that it is strictly impossible to define a measure of efficiency solely in terms of ex post observable variables. In addition it is shown that there exists a natural relationship between the measure of portfolio and the measure of efficiency. The model is then applied to the evaluation of the portfolios of 115 open-end mutual funds in the period 1945-1964. The main results are:

SECURITY PRICES, RISK, AND MAXIMAL GAINS FROM DIVERSIFICATION*

SECURITY PRICES, RISK, AND MAXIMAL GAINS FROM DIVERSIFICATION*