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Volume 37: Issue 5 (December 1982)

The Arbitrage Pricing Theory: Is it Testable?

Pages: 1129-1140  |  Published: 12/1982  |  DOI: 10.1111/j.1540-6261.1982.tb03607.x  |  Cited by: 126


This paper challenges the view that the Arbitrage Pricing Theory (APT) is inherently more susceptible to empirical verification than the Capital Asset Pricing Model (CAPM). The usual formulation of the testable implications of the APT is shown to be inadequate, as it precludes the very expected return differentials which the theory attempts to explain. A recent competitive‐equilibrium extension of the APT may be testable in principle. In order to implement such a test, however, observation of the return on the true market portfolio appears to be necessary.

A Theory of Capital Structure Relevance under Imperfect Information

Pages: 1141-1150  |  Published: 12/1982  |  DOI: 10.1111/j.1540-6261.1982.tb03608.x  |  Cited by: 105


Firms raise debt and equity capital to finance a positive net present value project in perfectly competitive capital markets; firm insiders know the function generating the random firm cash flow but potential capital suppliers do not. Taking into account the incentives of insiders to misrepresent their firm type, capital suppliers attempt to design financing mixes of debt and equity that eliminate the adverse incentives of insiders and correctly price securities. Necessary conditions for a costless separating equilibrium are developed to show that the amount of debt used by a firm is monotonically related to its unobservable true value.

Managerial Incentives in a Stock Market Economy

Pages: 1151-1167  |  Published: 12/1982  |  DOI: 10.1111/j.1540-6261.1982.tb03609.x  |  Cited by: 13


This study presents an analysis of the managerial incentive problem in a stock market economy in which incentive contracts are structured in terms of security ownership. In our model, the manager's ownership share signals effort and is determined endogenously as the solution to a special portfolio decision problem. Managerial investment in the firm is evaluated under various security pricing arrangements. Our analysis indicates that, in general, stockholders should sell shares to a manager at a discount to ensure a Pareto efficient ownership (incentive) structure. However, efficient pricing (discount) schedules generally are nonlinear and, in many respects, isomorphic to discriminating price functions which have been considered in neoclassical models of monopoly.

Sufficient and Necessary Conditions for Information to have Social Value in Pure Exchange

Pages: 1169-1181  |  Published: 12/1982  |  DOI: 10.1111/j.1540-6261.1982.tb03610.x  |  Cited by: 82


This paper extends, corrects, and unifies earlier statements concerning the social value of public information as well as the no‐trading conditions in pure exchange. Sufficient and necessary conditions are provided for both the single‐period and two‐period cases in a postsignal trading model. The social value of information is shown to be closely linked to the allocational efficiency of the market, the degree of homogeneity of prior beliefs, and of information structures, the time‐additivity of preferences, and the efficiency of endowments. We conclude that the case in favor of public information is much stronger than previously suggested.

Difference Systems in Financial Futures Markets

Pages: 1183-1197  |  Published: 12/1982  |  DOI: 10.1111/j.1540-6261.1982.tb03611.x  |  Cited by: 26


Many financial futures markets allow substitutions for the par grade of security at delivery. Substitutes are deliverable at premiums or discounts—“differences” in commodities parlance—to the futures price. The rule that establishes these differences is called a difference system. This paper characterizes financial futures market equilibrium with yield‐based difference systems and investigates particular systems in use. The major finding is that currently used difference systems effectively limit deliverable supply in the futures markets and lead to futures prices which understate the cash market price of the par security.

Rational Expectations and Risk Premia in Forward Markets: Primary Metals at the London Metals Exchange

Pages: 1199-1207  |  Published: 12/1982  |  DOI: 10.1111/j.1540-6261.1982.tb03612.x  |  Cited by: 29


This paper tests whether forward prices equal the traders' expectations of the future spot prices at maturity, under two different models of expectations formation: full information rational expectations and incomplete information mechanical forecasting rule. The tests are performed, over the period January 1970 through September 1980, on the forward markets for the primary metals—copper, tin, lead, and zinc‐traded in the London Metals Exchange. We find evidence consistent with the existence of time varying risk premia.

The Impact of Merger Bids on the Participating Firms' Security Holders

Pages: 1209-1228  |  Published: 12/1982  |  DOI: 10.1111/j.1540-6261.1982.tb03613.x  |  Cited by: 110


This paper investigates whether merger bids have an impact on the wealth of the participating firms' bondholders and stockholders. Monthly and daily bond and stock returns are calculated relative to the announcement date of a merger bid for a sample of conglomerate mergers. The results show that while the stockholders of target firms gain from a merger bid, no other securityholders either gain or lose. To provide direct evidence on the existence of “diversification effects” and “incentive effects,” we test whether the bondholders' returns are dependent upon the correlation between the returns of the merging firms and whether the size of the bondholders' and stockholders' returns in individual mergers are correlated. The results are consistent with a capital market that efficiently resolves conflicts of interest between stockholders and bondholders.

Tests of Two Models for Valuing Call Options on Stocks with Dividends

Pages: 1229-1237  |  Published: 12/1982  |  DOI: 10.1111/j.1540-6261.1982.tb03614.x  |  Cited by: 18


Roll has recently formulated an option pricing model which allows dividend payments on the underlying stock. This paper compares the performance of the exact Roll model with a modified, but inexact, Black‐Scholes model. The results indicate that the Roll model prices are significantly closer to actual market prices.

Municipal Bond Pricing and the New York City Fiscal Crisis

Pages: 1239-1246  |  Published: 12/1982  |  DOI: 10.1111/j.1540-6261.1982.tb03615.x  |  Cited by: 23


This paper's findings suggests that the New York City fiscal crisis by itself did not lead to a fundamental change in risk perceptions of investors, resulting in higher interest rates in the municipal bond market. The monthly prediction errors generated by time series tests were relatively small and none were statistically significant. Only the signs on the prediction errors for June, July, and August were consistent with a New York City effect. Thus, if the New York City default had an impact on aggregate interest rates, it was at most small and of short duration.

Optimum Distribution‐Free Tests and Further Evidence of Heteroscedasticity in the Market Model

Pages: 1247-1257  |  Published: 12/1982  |  DOI: 10.1111/j.1540-6261.1982.tb03616.x  |  Cited by: 25


In this paper several powerful distribution‐free tests for heteroscedasticity are introduced and are used to test the hypothesis of constant variance in the market model. These tests are noted for their flexibility in specifying alternative hypotheses. It is found that the assumption of homoscedasticity is untenable for the majority of stocks analyzed. The implications of this finding for the efficient estimation of the parameters of the market model are also discussed.

An Analysis of the Impact of Deposit Rate Ceilings on the Market Values of Thrift Institutions

Pages: 1259-1275  |  Published: 12/1982  |  DOI: 10.1111/j.1540-6261.1982.tb03617.x  |  Cited by: 20


This paper examines the impact of changes in deposit interest rate regulations on the common stock values of savings and loan institutions. The analysis indicates that stockholder‐owned savings and loans (S & L's) have experienced statistically significant declines in equity market values at the announcement of the removal of ceilings on certain consumer (small saver) certificate accounts and the introduction of short term variable rate money market certificates. We find the evidence to be consistent with the hypothesis that S & L's have earned economic rents from restrictions on interest rates paid to small saver accounts, and that relaxation of interest rate ceilings has reduced these rents.

A Disequilibrium Model of Savings and Loan Associations

Pages: 1277-1293  |  Published: 12/1982  |  DOI: 10.1111/j.1540-6261.1982.tb03618.x  |  Cited by: 1


This paper discusses the consistent specification and estimation of asset demand equations in a disequilibrium model of financial markets. We estimate the effective asset demands of savings and loan associations, allowing for rationing in the mortgage market. These disequilibrium estimates are not very different from the estimates of notional demands with no rationing assumed. Savings and loans seem to be least affected by excess demand situations in that they are apparently not reluctant to raise mortgage rates and/or to ration borrowers.

Additive Insurance Premiums: A Note

Pages: 1295-1298  |  Published: 12/1982  |  DOI: 10.1111/j.1540-6261.1982.tb03619.x  |  Cited by: 8


Stochastic Dominance Rules for Truncated Normal Distributions: A Note

Pages: 1299-1303  |  Published: 12/1982  |  DOI: 10.1111/j.1540-6261.1982.tb03620.x  |  Cited by: 8


The Demand for Life Insurance: An Application of the Economics of Uncertainty: A Comment

Pages: 1305-1309  |  Published: 12/1982  |  DOI: 10.1111/j.1540-6261.1982.tb03621.x  |  Cited by: 3


Book Reviews

Pages: 1311-1324  |  Published: 12/1982  |  DOI: 10.1111/j.1540-6261.1982.tb03622.x  |  Cited by: 0

Book reviewed in this article:


Pages: 1325-1328  |  Published: 12/1982  |  DOI: 10.1111/j.1540-6261.1982.tb00804.x  |  Cited by: 0