The Journal of Finance

Markowitz's “Portfolio Selection”: A Fifty‐Year Retrospective

Published: 12/17/2002   |   DOI: 10.1111/1540-6261.00453

Mark Rubinstein

Brokers versus Retail Investors: Conflicting Interests and Dominated Products

Published: 02/20/2019   |   DOI: 10.1111/jofi.12763

MARK EGAN

I study how brokers distort household investment decisions. Using a novel convertible bond data set, I find that consumers often purchase dominated bonds—cheap and expensive otherwise‐identical bonds coexist in the market. Brokers are incentivized to sell the dominated bonds, typically earning two times greater fees for selling them. I develop and estimate a broker‐intermediated search model that rationalizes this behavior. The estimates indicate that costly search is a key friction in financial markets, but the effects of search costs are compounded when brokers are incentivized to direct the search of consumers toward high‐fee inferior products.

Nonparametric Tests of Alternative Option Pricing Models Using All Reported Trades and Quotes on the 30 Most Active CBOE Option Classes from August 23, 1976 through August 31, 1978

Published: 06/01/1985   |   DOI: 10.1111/j.1540-6261.1985.tb04967.x

MARK RUBINSTEIN

The tests reported here differ in several ways from those of most other papers testing option pricing models: an extremely large sample of observations of both trades and bid‐ask quotes is examined, careful consideration is given to discarding misleading records, nonparametric rather than parametric statistical tests are used, reported results are not sensitive to measurement of stock volatility, special care is taken to incorporate the effects of dividends and early exercise, a simple method is developed to test several option pricing formulas simultaneously, and the statistical significance and consistency across subsamples of the most important reported results are unusually high. The three key results are: (1) short‐maturity out‐of‐the‐money calls are priced significantly higher relative to other calls than the Black‐Scholes model would predict, (2) striking price biases relative to the Black‐Scholes model are also statistically significant but have reversed themselves after long periods of time, and (3) no single option pricing model currently developed seems likely to explain this reversal.

Market Interest Rates and Commercial Bank Profitability: An Empirical Investigation

Published: 12/01/1981   |   DOI: 10.1111/j.1540-6261.1981.tb01078.x

MARK J. FLANNERY

The widespread notion that commercial banks “borrow short and lend long” implies that sharp market interest rate increases may induce a significant number of banking failures. This paper develops a method for estimating average asset and liability maturities for a sample of large money center banks. Regression models are tested to determine if market rate fluctuations have a significant impact on bank profitability. The conclusion is negative: large banks have effectively hedged themselves against market rate risk by assembling asset and liability portfolios with similar average maturities.

Asymmetric Information and Risky Debt Maturity Choice

Published: 03/01/1986   |   DOI: 10.1111/j.1540-6261.1986.tb04489.x

MARK J. FLANNERY

When capital market investors and firm insiders possess the same information about a company's prospects, its liabilities will be priced in a way that makes the firm indifferent to the composition of its financial liabilities (at least under certain, well‐known circumstances). However, if firm insiders are systematically better informed than outside investors, they will choose to issue those types of securities that the market appears to overvalue most. Knowing this, rational investors will try to infer the insiders' information from the firm's financial structure. This paper evaluates the extent to which a firm's choice of risky debt maturity can signal insiders' information about firm quality. If financial market transactions are costless, a firm's financial structure cannot provide a valid signal. With positive transaction costs, however, high‐quality firms can sometimes effectively signal their true quality to the market. The existence of a signalling equilibrium is shown to depend on the (exogenous) distribution of firms' quality and the magnitude of underwriting costs for corporate debt.

Testing An Aggressive Investment Strategy Using Value Line Ranks: A Comment

Published: 03/01/1983   |   DOI: 10.1111/j.1540-6261.1983.tb03642.x

MARK HANNA

Displaced Diffusion Option Pricing

Published: 03/01/1983   |   DOI: 10.1111/j.1540-6261.1983.tb03636.x

MARK RUBINSTEIN

This paper develops a new option pricing formula that pushes the underlying source of risk back to the risk of individual assets of the firm. The formula simultaneously encompasses differential riskiness of the assets of the firm, their relative weights in determining the value of the firm, the effects of firm debt, and the effects of a dividend policy with both constant and random components. Although this setting considerably generalizes the Black‐Scholes [1] analysis, it nonetheless produces a formula via riskless arbitrage arguments that, given estimated inputs, is as easy to use as the Black‐Scholes formula.

Risk‐Neutral Parameter Shifts and Derivatives Pricing in Discrete Time

Published: 11/27/2005   |   DOI: 10.1111/j.1540-6261.2004.00702.x

MARK SCHRODER

We obtain a large class of discrete‐time risk‐neutral valuation relationships, or “preference‐free” derivatives pricing models, by imposing a simple restriction on the state‐price density process. The risk‐neutral stock‐return and forward‐rate dynamics are obtained by changing only a location parameter, which can be determined independent of the preference and true location parameters. The Gaussian models of Rubinstein (1976), Brennan (1979), and Câmera (2003), and the gamma model of Heston (1993) are all special cases. The model provides simple relationships between expected returns and state‐price density parameters analogous to the diffusion case.

The Irrelevancy of Dividend Policy in an Arrow‐Debreu Economy

Published: 09/01/1976   |   DOI: 10.1111/j.1540-6261.1976.tb01972.x

Mark Rubinstein

Credit Risk in Private Debt Portfolios

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00056

Mark Carey

Default, loss severity, and average loss rates for a large sample of privately placed bonds are presented and compared with loss experience for publicly issued bonds. The chance of very large portfolio losses is estimated and some determinants of such losses are analyzed. Results show ex ante riskier classes of private debt perform better on average than public debt. Both diversification and the riskiness of individual portfolio assets influence the bad tail of the portfolio loss distribution. Private placements are similar to corporate loans in that both are monitored private debt. The results are thus relevant to management and securitization of private debt portfolios generally.

CORPORATE BANKRUPTCY POTENTIAL, STOCKHOLDER RETURNS AND SHARE VALUATION: COMMENT

Published: 06/01/1972   |   DOI: 10.1111/j.1540-6261.1972.tb00995.x

Mark Hanna

Computing the Constant Elasticity of Variance Option Pricing Formula

Published: 03/01/1989   |   DOI: 10.1111/j.1540-6261.1989.tb02414.x

MARK SCHRODER

This paper expresses the constant elasticity of variance option pricing formula in terms of the noncentral chi‐square distribution. This allows the application of well‐known approximation formulas and the derivation of a whole class of closed‐form solutions. In addition, a simple and efficient algorithm for computing this distribution is presented.

The Arbitrage Pricing Theory and Supershares

Published: 06/01/1989   |   DOI: 10.1111/j.1540-6261.1989.tb05057.x

MARK LATHAM

In a single‐period model with options on the market portfolio, linear factor pricing holds if and only if the variance of the market conditional on the factors is zero. There is no need for factors other than nonlinear functions of the market. For accurate linear pricing of all payoff patterns the factors must be rotationally equivalent to Hakansson's “supershares.” In a multiperiod model, a similar set of results holds, but with consumption replacing the market payoff. The methodology of the empirical Arbitrage Pricing Theory literature is not consistent with either the single‐period model or the multiperiod model.

SHORT INTEREST: BULLISH OR BEARISH?—COMMENT*

Published: 06/01/1968   |   DOI: 10.1111/j.1540-6261.1968.tb00826.x

Mark Hanna

AN INVESTOR EXPECTATIONS STOCK PRICE PREDICTIVE MODEL USING CLOSED‐END FUND PREMIUMS: COMMENT

Published: 09/01/1977   |   DOI: 10.1111/j.1540-6261.1977.tb03340.x

Mark Hanna

A Simple Formula for the Expected Rate of Return of an Option over a Finite Holding Period

Published: 12/01/1984   |   DOI: 10.1111/j.1540-6261.1984.tb04920.x

MARK RUBINSTEIN

Under conditions consistent with the Black‐Scholes formula, a simple formula is developed for the expected rate of return of an option over a finite holding period possibly less than the time to expiration of the option. Under these conditions, surprisingly, the expected future value of a European option, even prior to expiration, is shown equal to the current Black‐Scholes value of the option, except that the expected future value of the stock at the end of the holding period replaces the current stock price in the Black‐Scholes formula and the future value of a riskless invesment of the striking price replaces the striking price. An extension of this result is used to approximate moments of the distribution of returns from an option portfolio.

Informational Efficiency and Information Subsets

Published: 03/01/1986   |   DOI: 10.1111/j.1540-6261.1986.tb04490.x

MARK LATHAM

This paper proposes a new definition of the Efficient Markets Hypothesis with respect to information, which is more formal and precise than those of Rubinstein [13], Fama [4], Jensen [6], and Beaver [1], and which fits well as a framework for interpreting the many tests of the Efficient Markets Hypothesis in the literature. Security markets are here considered “efficient with respect to information set ϕ” if and only if revealing ϕ to all agents would change neither equilibrium prices nor portfolios. In addition to other desirable features, this definition has the “subset property”: efficiency with respect to ϕ implies efficiency with respect to any subset of ϕ.

Implied Binomial Trees

Published: 07/01/1994   |   DOI: 10.1111/j.1540-6261.1994.tb00079.x

MARK RUBINSTEIN

This article develops a new method for inferring risk‐neutral probabilities (or state‐contingent prices) from the simultaneously observed prices of European options. These probabilities are then used to infer a unique fully specified recombining binomial tree that is consistent with these probabilities (and, hence, consistent with all the observed option prices). A simple backwards recursive procedure solves for the entire tree. From the standpoint of the standard binomial option pricing model, which implies a limiting risk‐neutral lognormal distribution for the underlying asset, the approach here provides the natural (and probably the simplest) way to generalize to arbitrary ending risk‐neutral probability distributions.

Bond Systematic Risk and the Option Pricing Model

Published: 12/01/1983   |   DOI: 10.1111/j.1540-6261.1983.tb03832.x

MARK I. WEINSTEIN

In this paper we examine the behavior of the systematic risk of corporate bonds. A model that assumes β is constant is compared with a model that allows systematic risk to vary in a manner consistent with the Black‐Scholes‐Merton Options Pricing Model. This procedure captures some fundamental properties of the movement of bond β and provides a starting point for improved models of the process generating bond returns.

Towards a Semigroup Pricing Theory

Published: 07/01/1985   |   DOI: 10.1111/j.1540-6261.1985.tb05010.x

MARK B. GARMAN

In an arbitrage‐free economy, there will always exist a set of linear operators which map future contingent dividends of securities into their current prices. It happens that such operators will also form an “evolution semigroup” as a consequence of intertemporal analysis of the no‐arbitrage restriction. This paper summarizes some of the major implications of the semigroup properties, but avoids almost all of the technical discussion which underlies them. Instead, several practical examples are presented. Some well‐known continuous‐time results are replicated by this alternative method, and certain new developments are explored.