A major benefit of efficient markets is that observed market prices can be assumed to provide an accurate reflection of underlying intrinsic values. For a market to be efficient, however, sufficient numbers of market participants must engage in trading activity to ensure that observed prices are representative of the true but unobserved equilibrium price. Even though the pricing mechanism may impound the effect of all available information, the market price may be biased from the equilibrium price if the market is thin. This paper uses the price behavior of standardized call options traded on the Chicago Board Options Exchange to examine the relation between volume and inside efficiency.

The efficient market hypothesis implies that the issuance of market information is quickly, reflected in price changes and that the opportunity to profit from its content is highly improbable. This hypothesis has encouraged empirical research, and based on the consensus of evidence, the value of traditional security analysis is strongly questioned. Despite the rigor of these analyses the argument against traditional security analysis remains behaviorally and theoretically limited.

This paper develops a hypothesis regarding the factors which influence the average maturity of corporate debt, and the hypothesis is tested with a cross-sectional sample of large industrial firms. The sample consists of 159 companies from the Fortune 500 list of the largest industrial firms as of 1971. A linear regression model is developed with the firm's average debt maturity expressed as a function of the firm's asset maturity, size, variability of income, growth, and the proportion of debt in the firm's capital structure.

In their 1958 article Modigliani and Miller showed that if two firms are in the same risk class and in an economy with a perfect capital market having no transaction costs, taxes, or no bankruptcy costs, then their relative market values are independent of their capital structures.

A financial decision model of the firm, in which most prior deterministic decision models' assumptions were relaxed, was developed and solved for its policy and state variables' time-optimal trajectories. In particular, the three alternative modes of corporate financing, with their respective explicit and implicit costs, were treated as distinct, time-variant decision variables. In addition, their dynamic interdependent relationship with the firm's investment-possibilities schedule was clearly delineated. Besides eliminating the usual constant returns assumption, our model further introduced a dividends discount factor which was an explicit function of the firm's debt-equity ratio.

Furthermore, despite the generality of the model solutions, valuable economic implications were determined; namely, (1) conditions for the existence of a steady-state equilibrium were established with the critical role of nonproportional external equity flotation costs being observed; (2) the firm's dynamic equilibrium path was locally unstable in the initial, high-growth phase of its life cycle and was locally stable in its declining-growth stage–a result consistent with the growth literature in security valu ation theory; and (3) the usual assumptions of the balanced-growth path models are sufficient for the optimality of their decision policies.

We develop a household portfolio selection model that (1) generalizes some aspects of the conventional theory of the portfolio selection process; (2) integrates the investment and financing decisions, and (3) reflects the liability structure of the household. We incorporate the above influences by placing restrictions on the portfolio maximand in the form of probabilistic and deterministic constraints. The maximand is a tradeoff between the expected net value and the volatility of the portfolio as measured by Sharpe's beta coefficient. The maximization of the objective function is restricted by (1) the Cash Flow, (2) the Credit Limit, (3) the Adding-Up, and (4) the Non-Negativity constraints.

Choice under uncertainty may be viewed as choice between alternative probability distributions of returns. Under Von Neumann and Morgenstern's assumptions, an individual's optimal choice is a distribution that maximizes the expected utility of returns. In the theoretical analysis, the distribution functions are assumed to be known However, in most realistic cases, the distributions of returns are unknown and are estimated using available economic data. The traditional mode of analysis is to neglect the estimation risk and use the estimated distribution (in lieu of the true distribution) in determining the optimal choice under uncertainty. In this paper, we consider the portfolio choice problem and determine the effect of estimation risk on an individual's optimal choice under uncertainty.

It is clear from several previous empirical studies that diversification reduces portfolio return variability and that the reduction of variability appears very quickly. The purpose of this paper is to reexamine the question of how diversification affects the distribution of portfolio returns. There is no doubt that increasing the number of securities in a portfolio will reduce the nonmarket related return variability. However, there are several areas of controversy. For example, it should be recognized that the term “variability” can have different definitions. Furthermore, the ability of diversication to eliminate independent elements of the variability of return is important only if this reduction can be incorporated into predictions of future risk. In addition, the method of portfolio formation may determine the extent to which diversification enables portfolio managers to more accurately assist future risk.

From an historical perspective, the Federal funds market has evolved from primarily a receptacle for residual funds into a leading money market. During the market's formative years, banks borrowed Federal funds strictly as a reserve adjustment measure to supplement their discount window borrowings. Gradually, money market pressures have created a situation in which banking institutions find it profitable to finance some of their loan expansions and to expedite various types of transactions with the temporary use of these funds. Consequently, banks have reversed their earlier views and are presently treating discounting as being subservient to the purchasing of Federal funds. Initially, banks lent only their idle reserves in the funds market. In due succession, the practice of selling Federal funds replaced call loans as the predominant secondary reserve and has presently grown into a leading liquid asset in many banks' portfolios. Paralleling this rapid expansion has been the diversification of the funds market. Presently, one-third of the total volume of funds in this market originate from institutions other than commercial banks, i.e. U. S. Government Security Dealers and large corporations. Not only have the number and types of participants enlarged, but they tend to participate continuously rather than on an occasional basis.

The purpose of this study is to investigate the determinants of savings and loan profitability. Although considerable discussion has been devoted to studying the cyclical behavior of thrift institution profitability, there is a void with respect to the determinants of individual association profitability. This paper investigates whether performance variations are more determined by differences in the individual association's financial characteristics than by the external factors of the market in which they operate, such as state usury laws, market structure, and other economic characteristics of market areas.

The growing sensitivity of savings deposits to flow in response to changes in interest rate differentials has become so commonplace in the past decade that the term “disintermediation” has become a part of the economists' vocabulary. It is a major conclusion of this paper that the volatility of savings deposits began to increase as early as 1950 for savings and loan associations and credit unions and as early as 1945 for mutual savings banks. As an indication of this, we proxy changes in the competitive environment for savings deposits by making yearly estimates of the elasticity of savings deposits with respect to deposit rates at savings and loan associations, mutual savings banks, and credit unions.

The financial experiences of the last two years impel a careful and wide-ranging review of the stability of our major types of financial institutions. That review ought to be followed by actions to redress weaknesses or proclivities that, upon analysis, are judged to contribute an undesirable degree of instability within the financial system.

The basic thesis of this paper can be summarized very briefly. The regulatory structure and set of laws and procedures that have served us well in dealing with the failures of small banks in the past are not optimal in a world in which large banks can fail. The paper suggests some alternative means of improving the situation and stresses that any future discussions concerning reorganization of the regulatory agencies should keep in mind the need to improve our ability to handle the large bank failure.

The question of whether large banks should be allowed to fail brings us face to face with a conflict between two social goals. On the one hand, the goal of optimal resource allocation suggests that even very large banks, like other firms, should be allowed to fail. On the other hand, the stabilization goal suggests that, given the present institutional structure, failures of large banks should be prevented lest they lead to runs on other banks and to a significant reduction in the money stock. The solution suggested here for this conflict is small changes in the institutional structure.

The business of banking has changed profoundly over the past 15 years, and some of these changes have come to entail serious problems during periods of severe stress in financial markets. In part, banking changes have contributed to financial instability (actual and potential), and in part banking instability has reflected economic pressures. Recognizing the complexity of these influences, the need to anticipate problems–to keep “good” banks from going “bad,” as well as to keep “bad” banks from failing–is particularly urgent, especially since the economic environment in the years just ahead appears likely to be at least as unsettled as that of the recent past.

My comment was requested by the Chairman to be directed especially toward Dr. Robert Holland's excellent and thoughtful account of the changes, past and prospective, springing from the development of bank holding companies in American banking markets.

If I have read Professor Mayer's paper correctly, its basic message is that large banks should be permitted to fail. I agree with that position. Moreover, there have been two large-bank failures of late, and it is safe to infer that at least in a technical sense, the regulatory authorities also agree with Professor Mayer's position. However, implementation of that basic policy raises questions about the continued use of what have proved to be important institutional arrangements. As is well-recognized, failure carries with it a host of socially undesirable consequences, and for that reason an elaborate system of bank examination has been created at both the state and federal level to minimize the frequency of its occurrence. Thus, a policy position which permits any bank, large or small, to fail could imply the abandonment of bank supervision. I for one am not willing to go that far and I do not believe Mayer is either.

As an alteration of the firm's productive asset portfolio, divestiture is the mirror-image of asset acquisition or merger. Yet, though significant efforts have been expended by researchers into the implications of acquisition and merger, the literature of finance is all but silent on the subject of divestiture.

Recent evidence supports the notion that capital markets are substantially integrated in a return/systematic risk sense [1, 12]. Other studies show that investors can reduce the total level of risk borne without reducing expected returns by holding an internationally diversified portfolio [8, 9, 17]. Together these studies imply that the various economies mirrored by financial markets are not perfectly integrated. Some assert, however, that because of controls on capital flows, differential trading costs, different tax structures, and a number of other factors, markets are imperfectly (albeit substantially) integrated. Hence investors may not actually be diversifying internationally and thus forego advantages which would accrue to them if they were willing to hold foreign security issues.

Recent trends in capital budgeting have been toward more complex decision rules with increasingly sophisticated treatments of risk. Although they have the virtue of simplicity, undiscounted methods such as the payback do not account for the time value of money. Net present value and internal rate of return consider the time value of money but many questions remain about the proper discount rate, the reinvestment assumption, and the statistical interrelations among projects. The latest approaches, referred to as portfolio models, are substantially more complicated but are the only methods that consider the statistical interrelations among the various assets. The most popular portfolio approach has been the mean-variance (E-V) model developed by Sharpe [10] and Lintner [5].