Received monetary theory supports the existence of a strong relationship between monetary activity and stock prices. Following the work of Friedman and Schwartz [8], relating money supply to aggregate economic activity, some researchers have examined the more specific connection between changes in the rate of growth of money supply and associated movements in stock prices (see [6], [10], [11], [14], [17], [18], [19], [20], [22], and [28]). These studies use a variety of monetary aggregate measures to functionally relate the level of stock market indices to contemporaneous and lagged monetary growth rates. In general, the findings indicate a direct relationship between money supply and stock returns.

In two previous and related papers ([3], [4]), the authors have reported the results of estimating a particular equilibrium model of bond pricing using quarterly data on Canadian government bonds for the period 1964 to 1979. This paper reports the results of applying a similar model to the pricing of U.S. government bonds for the period 1958–1979 using data from the CRSP Government Bond File. The paper also extends the previous empirical analysis by evaluating the ability of the pricing model to detect underpriced and overpriced bonds: the data reveal a strong relation between price prediction errors and subsequent bond returns.

This paper investigates optimal consumption and portfolio mixture for a new discrete-time, discrete-state preference model. In this model, the investor's preferences for future consumption depend on current wealth and on past consumption experience through a summary descriptor of past consumption. Relations between the optimal consumption/investment decisions and the wealth and summary descriptor states are found.

The role of dividends in firm valuation continues to be a theoretical puzzle as well as an empirical obsession with economists. The pioneering work by Modigliani and Miller (MM) ([32], [29]) is the archetype of the theoretical dilemma. Whereas the authors proved convincingly the irrelevance of dividend policy to firm value within a perfect capital market, they tempered their irrelevance proposition with what is usually referred to as the “information content of dividends” (ICD) hypothesis. In a more scientific sense, this hypothesis should be labeled as a conjecture, since it is essentially an ad hoc observation that dividends may convey information to the capital market concerning a firm's future earnings potential. Even though the ICD hypothesis was not derived from a well-specified economic model, it has, nevertheless, been subjected to a plethora of empirical studies. In general, these studies have focused upon the precise influence of dividend changes upon a firm's common stock price. Overall, the results can be described as being supportive of the notion that stock price movements are positively correlated with cash dividend changes. This correlation, of course, is consistent with the ICD hypothesis.

The financial manager of the multinational corporation (MNC) is faced with various tax structures, changing exchange rates, barriers to capital flows, and the possibility of financial market segmentation. The manager must be concerned with determining an optimal capital structure as well as identifying the sources of the relevant funds. Likewise, the manager must be concerned not only with funds flows, but also with the risk that the value of these flows will change owing to changing exchange rates. Finally, the manager must be concerned with operating under widely differing governmental philosophies.

The major objective of Ken Eades' paper is to provide new insights into the role of dividend changes as information signaling devices. Eades argues that the traditional notion of the “information content of dividends” is based more on conjecture than on a well-specified economic model. Eades suggests that without a well-specified model, we are limited significantly in producing testable hypotheses about dividend signaling. Therefore, Eades extends the dividend signaling model of Bhattacharya [2] and provides statistical tests of the resulting hypotheses.

In recent years, increased interest has developed in municipal bonds. This interest seems to be related to higher levels of interest rates, higher marginal tax rates for individuals because of inflation, and large demand for capital funds by municipalities. In spite of this greater awareness of municipal bonds, the academic literature lacks a rigorous analysis comparing municipal bonds with other bonds. The purpose of this paper is to partially fill this gap. Since one major characteristic differentiating municipal bonds from other bonds is the (federal) tax-free status of the coupons on municipals, this paper will trace out the implications of this differential tax treatment by comparing municipal bonds with fully-taxed bonds.

One of the virtues of parameter preference models (presented in general form in Rubinstein [23]) is their empirical content. Applied models of financial theory rely heavily on the mean variance (MV) version of parameter preference. As spelled out in Samuelson [25], MV models are adequate with compact distributions of returns and when portfolio decisions are made frequently so that the risk parameter becomes sufficiently small.

Fewings [5] and Myers and Turnbull [13] have arrived at diametrically conflicting conclusions regarding the effect of growth on risk as measured by beta, the relative systematic risk in the Sharpe-Lintner-Mossin (SLM) capital asset pricing model. Fewings states his result in an unequivocal way: “…systematic capitalization risk of common stocks is undoubtedly a positive function of the rate of growth of expected corporate earnings” ([5, p. 53]) Myers and Turnbull, on the other hand, state their result in a more conditional form, making the result depend on the nature of market expectations revisions but conclude that “increasing the growth rate decreases B …” ([13], P. 327).

As an extension of previous works, we develop a theoretical framework for the relationship between monetary changes and market risk premia. The wealth effect and the return variability effect of money are shown to be the two important channels of the monetary impact on the market risk premium for three representative classes of utility functions. The theory also states that the market risk premium will be an increasing function of monetary changes given that the two component effects of money are positive.

Recently, agency theory has become popular as a means of explaining the structure of contracts between various classes of economic agents. Oftentimes the contracts of interest represent sharing rules for the payoffs that result from some production activity. In the usual two-party model of the contracting problem, one party designated the principal delegates authority for decisions affecting production to another party designated the agent. Typically, the assumptions made about the consequences of the agent's actions are that they are associated with effort on the part of the agent for which the agent (but not the principal) has disutility, and that greater effort will result in higher payoffs from production in every state of nature. Moral hazard is then introduced by assuming that the principal is unable to observe the agent's effort, or to infer what effort the agent applied through an ex post observation of the payoff that results.

In their article, “Beta as a Random Coefficient,” Fabozzi and Francis [1] present evidence which suggests that beta is a random coefficient for a “significant minority” of NYSE stocks. They obtained their evidence first, by characterizing the market model as a random coefficient model of the type described by Theil and Mennes [7], and second, by estimating its parameters for a sample of NYSE stocks over the period December 1965 through December 1971. This paper describes weaknesses in Fabozzi and Francis' implementation of the estimation procedures of Theil and Mennes [7] and Hildreth and Houck [3]. Improvements are suggested and utilized in an analysis of the returns of 683 NYSE stocks over the period January I960 through December 1971. The results of the analysis indicate that Fabozzi and Francis have overstated the case for beta being a random coefficient of the form described by Theil and Mennes.

The behavior of economic agents in the presence of uncertainty about exogenous events and imperfect information about the endogenously influenced actions of other agents with whom they contract has been receiving growing attention. In particular, the economic theory of agency explicitly recognizes that when agents enter into synergistic relationships, each agent will act in a manner consistent with the maximization of its personal welfare, thus giving rise to a phenomenon called moral hazard. Harris and Raviv [8], Holmström [10], and Shavell [21] have analyzed the nature of Pareto-optimal contractual mechanisms designed to ameliorate moral hazard and achieve efficient risk sharing. Jensen and Meckling [12], Grossman and Hart [6], and Thakor and Gorman [22] have explored the impact of moral hazard on the capital structure decisions of firms. Arrow [1] explained the absence of complete contingent claims markets on the basis of moral hazard, and Harris and Raviv [7] have examined the impact of moral hazard on the structure of health insurance contracts.

In recent years, there have been a number of studies investigating the yield spread phenomena between new and seasoned bonds ([1], [2], [3], [4], [8], [10], [13]). This literature focuses upon two aspects of the equilibrium pricing of new versus seasoned bonds: (l) analysis of the microeconomic determinants of new issue/seasoned issue yield spreads such as specific differences in coupon rates, call features, maturity features, and the like; and (2) analysis of macroeconomic determinants of yield spreads such as economic growth, interest rate cycles, changing marginal tax rates, and the like.

Hedgers adjust their futures market positions to reflect new information. Therefore, the anticipation of new information creates future decision points and thus a multiperiod decision problem. Previous studies (see [2], [4], [5], [7], and [8]) which solved the problem of choosing optimal futures market hedges have not addressed this issue. Rather, these studies have derived optimal hedges in one-period frameworks. In general, this solution is incorrect if, during the time the hedge is in effect, new information is anticipated.

Forecasts of financial prices, calculated from the present and past values, are never substantially more accurate than the prediction that future prices will equal the most recently observed price. This conclusion has been summarized by two hypotheses. First, the random walk hypothesis, states that daily returns are uncorrelated. Few people believe that this is exactly correct; indeed, the hypothesis has been refuted both for small stock markets [13] and for American commodity futures markets [3]. Second, the weak-form efficient market hypothesis, as defined by Jensen [15], states that investors cannot make profits from any correlation between returns, after deducting all the costs of trading and adjusting for risk. Strict efficiency, is a special case that occurs when prices fully reflect all information available in the past prices [7], [8].

The valuation of the firm in the context of the Capital Asset Pricing Model (CAPM) of Sharpe [22] and Lintner [18] brings into a new focus the product ion-investment decisions of the firm faced with demand and cost uncertainty. The market value of the firm and the level of systematic risk which arise from its product ion-investment decisions become items of primary importance. Although there are earlier treatments of the real determinants of valuation and risk in a dynamic context (e.g., Thomadakis [24] and Myers and Turnbull [20]), the case of a firm which experiments for the acquisition of information can furnish new insights.

The Black-Scholes [4] call option model is a member of the class of constant elasticity of variance call option models proposed by Cox [6]. While the Black-Scholes model assumes that the volatility or instantaneous variance of return is constant through time, the other members of the class allow the volatility to change with the stock price. This property is of interest because empirical evidence suggests that returns to common stock are heteroscedastic and also that volatilities, implied from the Black-Scholes model and market prices of call options, are not constant.

Schwartz [3] proposed a model to solve for the value of a warrant or an option when a closed-form solution of the valuation equation cannot be obtained. This model is based on a difference approximation of the valuation equation and uses standard numerical methods. We intend to show here that the same methods can be used to derive a difference approximation of the solution of the valuation equation which has a greater level of accuracy than Schwartz's approximation.

This paper uses the portfolio theory approach to bank behavior theory in order to examine the effects of two Fed policy variables on bank portfolio riskiness. The policy variables are (1) the level of the reserve requirement against NOW accounts, and (2) the rate of interest paid by the Fed on bank reserves. This second policy variable is currently zero-valued in nominal terms, but in recent years there has been some discussion of raising it, especially now that interest is paid by banks on checkable accounts. (For an early discussion see Tobin [8].)