Working Paper Abstracts – 1982
The Arbitrage Pricing Theory is extended to a setting where investors possess information about future asset returns. A no-arbitrage pricing restriction is obtained with arbitrage defined conditional on the investor’s information. The restriction can be stated with either conditional or unconditional expected returns, but both versions of the restriction contain the factor loadings identified from the unconditional covariance matrix of returns.
This study examines the inflation-related decline in real stock values since the mid 1960’s. An analysis of aggregate and cross-sectional financial data suggests that the negative relationship between inflation and economic profits is sufficient to explain a large part and perhaps all of the price decline, but that between inflation and either dividends or book earnings would explain only a small part of the decline. The study also suggests that inflation has been positively associated with increased risk, both diversifiable and nondiversifiable, and the implied increase in the required rate of return may be a significant secondary depressant of stock values.
The Speculative Efficiency Hypothesis is the proposition that a transform T of the current t-period forward exchange rate, T(Ft(t)), is an unbiased predictor of a transform of the spot exchange rate at time t+t, T(St+t). This paper argues that one should test Speculative Efficiency using daily data and the transform T(x) = log x, compare the usefulness of the forward rate to alternative predictors, and make allowances for heavy tails in the data — in particular considering the possibility that percentage, or log, changes in spot and forward rates have a non-normal stable distribution. Two tests — sample kurtosis and maximum-likelihood estimation of the characteristic exponent — show that if percentage, or log, changes in the daily spot and one-month forward dollar prices of DM over the period July 1973 to June 1979 follow a stable distribution, then this distribution is non-normal stable. This conclusion is not altered when allowance is made for time-varying scale or when tested in a model that allows for other types of distributions. The Speculative Efficiency Hypothesis is then tested using a regression procedure that is valid for non-normal stable distributions. The results show unambiguously that the log forward rate is an unbiased estimator of the future log spot rate. The log forward rate is not, however, useful: the current log spot rate is an equally good predictor, and the discount or premium on forward exchange has no relationship to future appreciation or depreciation of the spot rate. This empirical finding raises questions about the relevance of exchange rate models which assign a privileged role to the forward rate as an expectations variable.
This paper addresses econometric issues involved in using past prediction accuracy to derive optimal weights for a set of survey respondents’ current forecasts of economic variables. Both univariate and multivariate forecast aggregation techniques are discussed, and a general factor-analytic technique is presented to facilitate use of the methods in situations in which the number of forecasters is large relative to the length of performance track records. Several of these techniques are applied in a rolling fashion to the Livingston surveys of consumer price index and industrial production expectations. The performance of these forecasts, as measured by average bias and root-mean-square prediction error, indicates significant improvement over the naive forecast formed as a simple average over all respondents.
This paper considers a two-period, complete markets model in which consumers’ income from initial portfolio endowments is taxed at rates which depend both on the consumer being taxed and on whether the income is ordinary income or capital gains. Such differential taxation causes consumers to disagree about the objectives of the firm, both as these relate to the firm’s investment decision and the firm’s financial policy. While consumers will not unanimously favor any specific firm policy (in particular, most consumers will not favor firm value maximization), policies exist which are supported by a majority vote of the firm’s shareholders.
Established theory of optimal policy intervention prescribes the appropriate policy mix if (1) domestic firms hire labor at a distorted wage and (2) the domestic country wields international market power. Under these conditions, optimal policy generally requires that both a tariff and a subsidy to domestic employment are available policy tools. This paper measures the dependence on domestic and foreign demand and supply conditions of the proportion of first-best domestic welfare which can be achieved when only one of the two requisite policy instruments can be used.
For reasons of transaction or estimation costs, an investor would typically not hold the market portfolio even if he followed the mean-variance precepts of Markowitz. The paper shows that a variant of the one-parameter performance measure of “alpha” coefficient, originally proposed by Jensen does provide in some cases an inexpensive tool to screen a large number of potential additions or deletions to an existing portfolio. This use of the alpha coefficient as a tool in portfolio selection does not assume the descriptive validity of the Capital Asset Pricing Model.
The law of one price (LOP) is tested for narrowly defined commodities traded in futures markets in different countries during the period 1973–1980. Although the LOP holds as an average tendency for most of the commodities, there are instances of large riskless arbitrage returns (before transactions costs). One cannot conclude from this that international commodity markets are inefficient or that arbitrage fails to take place since large gross returns to arbitrage may be explained by tariffs or large costs of arbitrage that we do not observe directly. Deviations from the LOP tend to be commodity specific rather than due to a common external factor and they tend to be smaller the longer the maturity of the futures contract.