How households shift spending across firms in response to income fluctuations is an important source of firm risk. Using transaction-level data, we study how households interact with the universe of retailers following income changes. We find that income increases within and across households result in substitution toward retailers in a category that are higher quality; smaller; more profitable; and have higher labor intensity, research and development (R&D) intensity, and equity betas. Although not all shifts are economically large, they do not average out across retailers. Thus, retailer choice has implications for key financial and macroeconomic outcomes, such as aggregate profitability and labor demand.

The analysis has shown that insurer investment performance parallels that of other investors; greater returns are associated with greater variability. However, with the acquisition of higher levels of investment risk insurers generally reduce the level of underwriting risk which is undertaken. Thus, insurer management apparently attempts to keep ruin probabilities within some undefinable but clearly present limits. In the process of trading off between investment and underwriting risk, a higher rate of return to net worth is sacrificed.

The sacrifice of potentially higher rates of return to equity, however, does not place the insurer at a disadvantage relative to the capital market or make attractive the alternative of operating as an investment trust. Under reasonable conditions governing the risk and return associated with underwriting activities, the insurer return to net worth is in a more efficient position as the result of underwriting activities than that offered by the capital market alone. For a given risk position, the return to the insurer exceeds that available from the capital market alone. Thus, so long as marginal returns to underwriting are positive, the leveraging afforded by the expansion of premium volume produces a superior return over the traditional leveraging which might be employed by an investor in the capital market.

The rationality of compensating balance requirements has been widely debated in the literature and among participants in the market for loanable funds. Rationality in this context refers to a net gain in interest income for the lending bank in the transaction without, at the same time, an increase in interest cost to the borrowing firm; or, conversely, a decrease in interest expense to the borrower without, simultaneously, a decrease in income derived from interest on the transaction by the bank. The lack of consensus as to whether or not compensating balance requirements are rational is based on the absence of uniform assumptions regarding the imposition of these requirements as well as by their restrictive, if not unrealistic, nature. Thus, Davis and Guttentag [2] and Hodgman [9] come to the conclusion that compensating balance requirements (hereinafter also known as c.b.) are indeed rational. However, this conclusion is based on the assumption that the borrowing firm maintains voluntary demand deposits in the lending bank or in another bank (i.e., balances that the firm employs for transaction and/or precautionary purposes which do not serve to satisfy c.b. for any loan or service performed by either bank) and that these deposits are sufficient in quantity to meet c.b. On the other hand, Hellweg [8] finds the use of c.b. irrational inasmuch as he assumes a lack of voluntary balances in either bank. In between these two extremes, Gibson [7], Shapiro and Baxter [11], and Wrightsman [13] suggest that c.b. may either be rational or irrational depending on the proportion of these balances satisfied through the voluntary holdings of the borrowing firm.

This paper is concerned with costs of capital in mathematical programming formulations of the problem of capital budgeting under capital rationing. It shows that there is a serious error in the method outlined by previous authors for converting the shadow prices from the solution of the dual into measures of the firm's marginal internal opportunity rates. In addition to demonstrating that the traditional approach leads to erroneous and nonsensical results, this paper presents a correct procedure for determining these rates.

Most large companies develop formal or informal agreements with banks to cover anticipated seasonal or temporary cash needs and/or to provide assurance of the availability of funds against unanticipated cash requirements. We address the problem of determining the optimal limits of available funds a company should maintain under a revolving credit agreement. Typically a company will negotiate a legal commitment with a bank or group of banks for a specified period of time, usually one to three years, in which the bank agrees to extend credit up to a specified maximum amount. During the duration of the commitment, the bank must lend money to the company whenever the company wishes to borrow, provided the amount of money borrowed does not exceed the maximum amount noted in the agreement. The company must not be in default of any of the restrictive covenants of the agreement, such as working capital limits, compensating balances, limits on other indebtedness, etc. Although the agreement itself provides for intermediate-term financing, the agreement often takes the form of short-term (30-60-90 days) renewable notes.

Not all racetrack bettors want to handicap. Some prefer to buy expert opinion on the winners of each race and on the day's best bet. Investors are not very different. Many like to avoid the analysis required to choose among investment funds and so seek some summary measure that will rank funds relative to one another and indicate which one is the best bet. Two measures suggested in work by John Lintner [2], William Sharpe [6], Jack Treynor[7], and Henry Latané and Donald Tuttle [1] rank investment funds considering both return and risk. These measures not only can be taken to provide an indication of the best bet among investment fund managements but also offer a guide to building a portfolio.

Some recent works dealing with the subject of investment in common stocks have made cautious reference to the potential of some published, leading economic time series as inputs to stock price forecasting models. However, no prominent reports of systematic empirical research of the predictive usefulness of such series have appeared in the literature. Our study was designed to partially correct this seeming oversight.

The relationship between return on assets and their riskiness is one of the liveliest topics in financial literature. In his 1952 landmark article, Markowitz developed a mathematical model that captured this key financial concept. defined risk as the variance of the rate of return of a portfolio. Later, Sharpe hypothesized a positive linear relationship between expected rate of return on an asset and the risk premium associated with that asset. Subsequently, Sharpe tested this hypothesis empirically and found support for his theory. Although portfolio theory specifies the two parameters of this model as ex ante return and risk, Sharpe used ex post data for testing the risk-return relationship. designated the ex post mean rate of return obtained on an an asset as a proxy for expected return and the standard deviation of ex post annual rates of return as a surrogate for risk.

Two measures of investment worth: the discounted-rate-of-return and the payback method will be compared here. Many examples can be found in the literature illustrating the serious limitations of the payback method.

According to these examples, an investment proposal may be judged economically undesirable when in actual fact it is highly profitable. This happens when the annual cash flow is not equal, and the investment project promises a relatively large cash flow after the cut-off period.

We examine the costs of trading restrictions by exploiting an SEC rule change eliminating an approximately 80-day restriction period in private placements for small issuers. Using a difference-in-differences specification, we find that the restriction is binding, as dollar volume increases 19 percentage points vis-à-vis proceeds, and costly, as offering discounts fall by 8 percentage points. Discounts fall more for issuers with higher information asymmetry or longer restriction periods. We account for endogenous responses to the rule change. Overall, our findings suggest that trading restrictions are costly and have large effects on firms’ cost of capital.

We relate Schumpeter’s notion of creative destruction to asset pricing, thereby offering a novel explanation of size and value premia. We argue that small-value firms must offer higher expected returns to compensate for the risk posed by serendipitous invention activity, whereas large-growth stocks provide protection against creative destruction and receive expected return discounts. A 2-factor model that accounts for creative-destruction risk effectively explains the cross-sectional return variation of size- and book-to-market-sorted portfolios. The estimated risk compensations associated with creative destruction are substantial and statistically significant, indicating their relevance for asset pricing.

We document a strong decline in corporate-diversification activity since the late 1970s, and we develop a dynamic model that explains this pattern, both qualitatively and quantitatively. The key feature of the model is that synergies endogenously decline with technological specialization, leading to fewer diversified firms in equilibrium. The model further predicts that segments inside a conglomerate should become more related over time, which is consistent with the data. Finally, the calibrated model also matches other empirical magnitudes well: output growth rate, market-to-book ratios, diversification discount, frequency and returns of diversifying mergers, and frequency of refocusing activity.

Institutional demand for a stock before its earnings announcement is negatively related to subsequent returns. The relation is not attributable to the price pressure of institutional demand and is stronger for stocks with higher information asymmetry and/or greater valuation difficulty. These findings support the notion that overconfident institutions misprice stocks. Following announcements, institutions’ behavior exhibits the outcome-dependent feature of self-attribution bias. Whether they become more overconfident and delay their mispricing correction depends on whether earnings news confirms their preannouncement trades. This behavioral bias also offers a new explanation for the well-known post-earnings-announcement drift.

Evidence provided here suggests that investors could have identified, ex ante, portfolios that hedge against uncertainty in the prices of three major categories of consumption: food, shelter, and transportation. This finding has implications for the practical importance of multi-period capital asset pricing theories that assume investors can identify such hedge portfolios. The study also provides some surprising evidence about the usefulness of common stocks and commodity futures contracts in hedging against specific price inflation. Certain combinations of common stocks serve as effective hedges, but combinations of commodity futures contracts contribute nothing to hedging ability.

We show that a simple, intuitive variable, Goliath versus David (GVD), reflects time variation in discount rates related to changes in aggregate business conditions. GVD is the annual change in the weight of the largest 250 firms in the aggregate stock market and is motivated by research that shows that small firms are more severely impacted than large firms by economic shocks due to differences in access to external finance. We find that GVD is the best single predictor of out-of-sample market returns among traditional predictors, predicting quarterly market returns with an out-of-sample R2 of 6.3% in the 1976–2011 evaluation period.

It is widely assumed in portfolio theory that investors are risk-averse expected-utility maximizers. There is a good theoretical reason for assuming expected-utility maximization. Such behavior is well known to be consistent with several quite plausible postulates of rationality [5]. On the other hand, the main empirical foundation for such behavior in portfolio selection appears to be the observation of diversification. Risk-averse, expected-utility maximization implies diversification in portfolio selection, and investors are observed to diversify.

Deposit variability in banking has received substantial attention in recent empirical studies [1], [2], [3], [4], [5], and [7], Most of these efforts have been cross-section analyses of the determinants of variability. However, the impact of branching on deposit variability has not been tested in any of these studies. Wacht suggests that branching could reduce deposit variability substantially, especially if geographical dispersion could be achieved through relaxing interstate restrictions on branching [6]. In this paper, Wacht's suggestions will be subject to empirical testing for one thrift institution located in a major eastern metropolitan area. In Section I, the test methodology is presented. Data sources and empirical results are discussed in Section II, while the study is summarized and the implications for future research are discussed in Section III.

In many circles the Mean Variance Capital Asset Pricing Model (MV CAPM) is synonymous with the theory of capital asset pricing. But in a single-period discrete-time model which explicitly recognizes the existence of limited liability the derivation of the MV CAPM, if it is to be consistent with the von Neumann-Morgenstern postulates of rational behavior, must be based on the assumption that all investors have quadratic utility functions. This assumption in turn implies that risky assets are inferior goods. However, if we turn to the broader class of linear risk tolerance (LRT) utility functions, for which the separation property holds, other simple two-mutual-fund CAPMs can be derived. The power utility LRT CAPMs are of particular interest as they are consistent with risky assets being normal goods.

By focusing attention on managers' concept of risk and the methods they use to measure risk, this paper attempts to lessen the disparity between current theory and practice by suggesting a method that will make IRR and NPV more generally applicable. We attempt to do this through a methodology that combines some PERT assumptions with traditionally accepted academic techniques and those used by practicing business managers to provide a probability distribution of the cumulative net present value (CPV). From these data we develop a probability distribution of the discounted payback period.

In his recent paper in this Journal, Miller [3] proposed, following Adler's results [1], that “the investor exhibits decreasing absolute risk aversion with respect to expected wealth if, as increased holding σ constant, the slope of the indifference loci decreases” [3, p. 301]. He further attempted to have shown that in general the sign of () is the same as the sign of r'(W) (the derivative of the absolute risk aversion measure), but this is not proved.