Working Paper Abstracts – 1971
A New Look at the Capital Asset Pricing Model
Marshall E. Blume and Irwin Friend
In a recent paper in the American Economic Review, we presented empirical evidence that the relationship between rate of return and risk implied by the market-line theory is unable to explain differential returns in the stock market. As a result, the risk-adjusted measures of portfolio performance based on this theory yield seriously biased estimates of portfolio performance. We advanced but did not test several tenable reasons for these observed biases, which included the inability of investors to borrow large amounts of money at the same risk-free interest rate at which they can lend, and deficiencies in the return generating models which are required to translate ex post or realized into ex ante or expected returns and “risks”. Recent papers by Fischer Black and Stephen Ross present theoretical models which suggest that the breakdown of the borrowing and lending mechanism would be expected to bias these measures, but not for explicit reasons we gave.
The purpose of this paper is to examine both theoretically and empirically in greater depth than was done previously the reasons why the market-line theory does not adequately explain differential returns on financial assets. The first section of the paper briefly reviews the salient points of the market-line theory as recently modified and analyzes the implications of the theory. The second section estimates several types of risk-return tradeoffs implied by stocks on the New York Stock Exchange for three different periods after World War II and shows that the empirical results cast serious doubt on the validity of the market-line theory in either its original form or as recently modified. On the other hand, these results do confirm the linearity of the relationship for NYSE stocks. The third section suggests that the market for NYSE stocks is segmented from the bond market unless the return generating process is different from any heretofore tested. This has important implications for both the measurement of portfolio and the determination of optimal corporate financing.
Dividend Announcements, Security Performance, and Capital Market Efficiency
Richardson R. Pettit
Price Impacts of Block Trading on the NYSE
Alan Kraus and Hans R. Stoll
In an efficient market, prices reflect underlying values. This insures the proper allocation of new funds to the most productive areas of the economy. Additionally, individual investors benefit by knowing that prices at which they trade are not subject to forces which have little or nothing to do with the underlying value of the company.
Extensive empirical tests which tend to support the efficiency of the stock market have been carried out in the past. Until recently, however, no tests have been carried out to assess directly the impact of institutional investors on the efficiency of the stock market. The purpose of this paper is to examine the extent to which block trading by institutional investors contributes to or detracts from efficient markets. A block trade can be defined as a transaction involving a larger number of shares than can readily be handled in the normal course of the auction market.
Efficiency of Corporate Investment
Irwin Friend and Frank Husic
The Economic Consequences of the Stock Market