Unfortunately Professors Arditti and Levy (A-L) in their comment published in this issue of this journal did not realize that the determination of the investor optimum in my paper [1] was simultaneous with respect to the three parameters, the mean and the variance and the third moment of portfolio returns. When the nth moment was introduced, it was assumed that the investor chooses on the basis of all n parameters — the mean, second moment, third moment, etc. — through the nth moment.

In “Valuation Under Uncertainty,” which recently appeared in this Journal (September 1967), Houng-Yhi Chen argues [1, pp. 313–314] that “Robichek and Myers' criticism [2, 3] of the use of the risk-adjusted discount rate is unfounded,” and suggests that our “conclusions must be based in part on a misunderstanding of the risk-adjusted discount rate method.” These charges are without foundation, as we will show here.

A perfect capital market is a key assumption in recent theories of security pricing. It is assumed that the costs of transactions, information-gathering, and portfolio management are all zero, and that no investor is so large as to exert an appreciable effect on either the risk-free interest rate or the yield on risky securities. If, in this perfect capital market, investors have identical decision horizons and homogeneous expectations, then there is a unique optimal portfolio of risky securities. Since this unique portfolio must include every security in proportion to its relative valuation in the capital market, it is referred to as the “market” portfolio. When the capital market reaches equilibrium, the expected return of every security will be a linear function of the expected return of the market portfolio. From this relationship Lintner and Mossin have separately derived valuation formulas that express the market price of a security as a function of the security[s end-of-period expected value, its risk as measured by the variance and covariances of this end-of-period value, the market price of risk within the portfolio, and the risk-free rate of interest.

This article analyzes the informative trading of professional money managers within a rational-expectations equilibrium model in which managers care about their performance relative to their peer group. I find that the existence of uninformed managers causes informed managers with relative performance concerns to trade less informatively, engendering less informative prices. When managers are differentially informed, they need to forecast the average performance based on private signals, and each manager may place more weight on the private signal if the signal provides good information about the average performance. The price aggregates those signals and thus becomes more informative.

Using unique real estate data that allow for accurately measured capital gains, we examine whether sell propensities depend on the magnitude of a seller’s capital gain. We find that short-term sell propensities are flat over losses and increasing in gains. Consistent with their higher sell propensities, selling prices are lower for properties with larger gains. Large-sized short-term stock investments also have sell propensities that are flat over losses and increasing in gains, although the sell propensities of typical-sized short-term stock investments are V-shaped. Our findings provide empirical support for theories of realization utility.

A number of futures contracts conveys to the short position various delivery options regarding the quality and exact timing of delivery. Moreover, the compensation to the long position is not solely determined by the market value of the delivered asset at the time of delivery. Sometimes, the long position can hedge this delivery risk by holding an appropriate portfolio of the underlying asset. It often has been stated that whenever the long position can form a dynamic hedge against the delivery risk, the delivery option has a zero value. This paper demonstrates the implication of such erroneous intuition to the pricing of options. It is shown that the root of the issue is the property of diffusion processes whereas, within a given time interval, a random variable either will never cross a given boundary or else, cross it an infinite number of times.

Economists generally agree that a basic characteristic of a good tax is economic neutrality. That is, a tax should not influence economic behavior unless it was intentionally designed to produce a specific effect. In this context, the economic effects of the current system of capital gains taxation in the United States have been the subject of considerable concern. Most researchers have concluded that the current system of capital gains taxation has an undesirable and destabilizing effect on the securities markets because the practices of taxing capital gains only when they are realized and, correspondingly, allowing tax deductions for capital losses only upon realization, presumably cause investors to defer the realization of capital gains and to accelerate the realization of capital losses. Based upon this behavioral assumption, many economists infer an effect on the securities markets.

In a recent paper in this Journal Francis [3] has examined the intertemporal systematic cross dependence between the monthly returns of securities and those of a market index. Based on the monthly price behavior of a sample of 770 common stocks listed continuously on the New York Stock Exchange (NYSE) from 1958 to 1967 he concludes that, relative to the general market movement, there is no consistent pattern of leads or lags for securities' monthly returns. In other words, the monthlyreturns of securities do not precede or follow the monthly returns on the market index.

In a recent article in this Journal, Jacob B. Michaelson and Robert C. Goshay (hereafter M-G) argue that the rule of maximizing share values does not adequately explain the portfolio selection practices of financial intermediaries. Moreover, M-G suggest that their analysis “has ramifications that reach far beyond financial intermediaries.” In particular, they state that “the asset holdings of conglomerate firms and the rationale for mergers may not be fully explicable in terms of maximizing behavior.”

A portfolio frontier superior to the Markowitz one-period buy-and hold efficient frontier does exist. Such a superior frontier can be generated by pursuing a rebalancing policy, even under the conditions of random walk. By rebalancing we mean that an investor maintains a fixed but optimal set of weights among the securities in a portfolio throughout an investment period by buying and selling securities at the end of some predetermined intervals.

Among the many financial problems facing managers of firms, capital budgeting problems are often the most important. Over the years these problems have received considerable attention from financial economists with more recent work emphasizing two separate approaches. One currently popular approach to capital budgeting is based on the simple linear relationship between risk and return from the intertemporal capital asset pricing model (CAPM) of Merton [20]. Papers in this category include Brennan [7], Bogue and Roll [4], Treynor and Black [26], Myers and Turnbull [21], Fama [15], Bhattacharya [2], and Constantinides [9].

The evolution of corporate capital structure theory in the literature of finance has been marked by the development of an increasingly imaginative rendition of market processes under conditions of uncertainty. Trade-offs between debt and equity sources of financing, and their consequent impact on shareholder wealth, have been the major concern. While the evolution is by no means complete, the notion of an efficient capital market in which investor decisions are focused on security portfolio building activities has provided significant insights into the range of opportunities open to corporate management to enhance share valuation through enlightened financing decisions. One measure of the gap between theory and application, however, can be found in the topics which thus far have not been effectively comprehended in the literature, even though the analytical technology is clearly available. Among those topics is the question of convertible debt financing as a capital structure component. The treatment of such a funds source remains essentially in the realm of folklore, the typical story being that convertibles contain the “best elements” of both equity and straight debt or that they provide a vehicle for issuing equity at a “bonus” price higher than the current price. Closer examination reveals that either view is arrant nonsense, and it is to a demonstration of this point that the present paper is addressed.

We study the quoting activity of market makers in relation to trading, liquidity, and expected returns. Empirically, we find larger quote-to-trade (QT) ratios in small, illiquid, or neglected firms, yet large QT ratios are associated with low expected returns. The last result is driven by quotes, not by trades. We propose a model of quoting activity consistent with these facts. In equilibrium, market makers monitor the market faster (and thus increase the QT ratio) in neglected, difficult-to-understand stocks. They also monitor faster when their clients are more precisely informed, which reduces mispricing and lowers expected returns.

This paper is another step in an attempt at unification, through generalization, of existing theories in various areas of finance. The subject treated here is the valuation of equity shares.

This note examines the positive implications of the Latané-Tuttle [5, 6] geometric mean portfolio selection criteria for the determination of stock prices. Recently, Mossin [9] and Lintner [10] have derived the market prices of equities under the respective assumptions that investors have quadratic and exponential utility functions. While it would be presumptuous to suggest that all investors are “long-run wealth” maximizers, this criterion has a certain amount of intuitive appeal. The geometric mean criterion is equivalent to the maximization of a Bernoulli or logarithmic utility function and displays the desirable characteristic of decreasing absolute (i.e., as the investor's wealth increases, he becomes less averse to risk). This contrasts with the exponential utility function which displays constant absolute risk aversion and the quadratic utility function which displays the undesirable characteristic of increasing absolute risk aversion. Another suggested desirable characteristic of the geometric mean criterion is that it emphasizes the avoidance of bankruptcy while maximizing the asymptotic rate of growth of wealth [4, 5] and maximizing the probability of exceeding a given wealth level within a fixed time [3]. This note analyzes the aggregate effect on stock prices of investors using the geometric mean portfolio selection criterion.

Standard portfolio choice models predict that investors consider the tax implications of trading. However, individuals are disposed toward realizing gains and holding losing investments, behaviors that worsen their performance. We show, in an experimental market, that increasing tax salience reduces the disposition effect between 22% and 47%, leading to higher portfolio balances without increasing total trading activity. Using field data, we find that investors’ disposition is sensitive to taxes around tax rate changes when taxes are likely salient. Our analysis demonstrates that increasing tax awareness can affect households’ portfolio choices, which suggests policy implications for improving financial decision-making.

A short squeeze occurs if borrowed shares are recalled and the short seller is unable to find another source of shares. This forces the short seller to terminate a position early. For most stocks, the probability of a short squeeze is very low. Short squeezes, however, are not unusual for the hardest to borrow stocks. For these stocks, trading costs from squeezes are high and have a significant impact on the returns to short selling. For hard-to-borrow stocks, short sellers also miss out on significant abnormal returns because squeezes force them to close positions.

Using random H-1B visa lotteries as a natural experiment, we find that firms respond to shortages of high-skilled workers by acquiring firms that employ such workers. The effect is stronger among firms with high human capital and more senior workforces, firms facing tight labor markets and legal barriers to poaching workers, and firms lacking foreign affiliates. The acquired workers are highly educated, sharing skills and occupations similar to those of the acquirer’s existing workers. Our findings suggest skilled labor is an important driver of acquisitions and acquiring is an effective means of obtaining skilled labor.

The pivotal role of earnings expectations in equity valuation and therefore in certain areas of business finance is widely recognized, yet there is little theoretical or empirical evidence as to the manner in which investors and other groups actually formulate their estimates of future earnings. The resulting necessity to utilize proxy or indirect measures of expected earnings specified largely according to the predispositions of the investigator has led to numerous difficulties in the testing of cost of capital propositions and models of equity valuation.1 This study is intended to supply a preliminary response to the question of how earnings expectations are determined by appraising the extrapolative component of a limited sample of short-term estimates of earnings per common share. More specifically, the issues are the extent to which the earnings estimates (1) are extrapolative in nature and (2) may be approximated by familiar, naive, extrapolative techniques. In this context, “extrapolative” simply means determined by application of a specified weighting scheme to prior observations in the time series.

Recently, several researchers, including Evans, Archer [1], Latané, and Young [2], have performed empirical analyses of the relationship between the number of securities in a portfolio and the reduction in portfolio dispersion. In this note, an exact mathematical relationship between these two factors is presented.