bond indenture provisions and the risk of corporate debt abstract this paper examines the effect of alternative bond indenture provisions on the allocation of risk among the firm s claimants the approach taken here differs from that of earlier studies in that risk allocation is examined while the firm s leverage in market value terms is held constant in this context four indenture provisions are examined 1 the time to maturity 2 the promised payment schedule 3 financing restrictions and 4 priority rules it is concluded that risk is transferred from stockholders to bondholders as the time to maturity and promised payment increase appropriately furthermore substitution of longer term debt for an equal amount of shorter term debt also increases the risk to bondholders while decreasing the risk to stockholders the analysis shows that a coupon bond can be represented by a unique discount bond with the same risk and value this permits the characterization of the effective maturity of a risky debt issue a concept analogous to the stochastic duration of a default free coupon bond these results are shown to be independent of the means used to finance the debt issue finally it is concluded that the relative risk associated with different bonds issued by the same firm cannot be determined by the structure of priority rules alone it is also necessary to consider the timing of the promised payments compared to that of the other debt issues in the firm s capital structure

subjective stochastic dominance put writing and stock purchases with extensions to option pricing and portfolio composition initially an investor has the choice of two risky assets writing a european put option or buying the underlying share under broad conditions a risk averse investor will be subjectively better off writing the put when homogeneous expectations are invoked an upper bound for the put premium is obtained a numerical example using the lognormal density function illustrates the broad conditions for risk averters subjectively preferring the put writing strategy additional conditions permit this preference for writing puts to be extended to the portfolio context transactions costs only reinforce this preference in the one period horizon considered

option bounds with finite revision opportunities this article generalizes the single period linear programming bounds on option prices by allowing for a finite number of revision opportunities it is shown that in an incomplete market the bounds on option prices can be derived using a modified binomial option pricing model tighter bounds are developed under more restrictive assumptions on probabilities and risk aversion for this case the upper bounds are shown to coincide with the upper bounds derived by perrakis while the lower bounds are shown to be tighter in 1984 perrakis and ryan 6 derived upper and lower bounds on european option prices in discrete time and under modest assumptions on preferences and

upper and lower bounds of put and call option value stochastic dominance approach applying stochastic dominance rules with borrowing and lending at the risk free interest rate we derive upper and lower values for an option price for all unconstrained utility functions and alternatively for concave utility functions the derivation of these bounds is quite general and fits any kind of stock price distribution as long as it is characterized by a nonnegative beta transaction costs and taxes can be easily incorporated in the model presented here since investors are not required to revise their portfolios continuously the price that is paid for this generalization is that a range of values rather than a unique value is obtained in the last decade there has been an increasing interest in the options market by both academicians and practitioners the most well known valuation models are the black scholes 4 model the jump stochastic process model see cox and ross 6 the binomial model see cox ross and rubinstein 7 rendleman and bartler 19 and sharpe 22 and rubinstein s discrete model 21 recently perrakis and ryan 18 using rubinstein s approach have derived upper and lower bounds for option prices the relative pricing theory of contingent claims differs in the continuous time and discrete time models in a continuous time framework the instantaneous expected rate of return of the option and that of the underlying stock must follow a certain market equilibrium condition in this case the equilibrium condition is easily determined by a continuous hedging strategy in the discrete time case there is no hedging strategy to provide a simple relationship between the option and the stock price however for a given value distribution of the stock the value distribution of the option is uniquely determined by the option exercise price and this suggests some possible relationships between the stock and option values

does the bond market predict bankruptcy settlements this study shows the extent to which deviations from the absolute priority rule increase or decrease the bankruptcy emergence payoff to traded i e usually junior claimants bondholders the data indicate that on average bondholders benefit albeit slightly from absolute priority rule apr violations this paper also examines the degree to which the bond market in the bankruptcy filing month anticipates departures from the apr and other influences on the payoff to bondholders in other words we investigate the informational efficiency of the market for bankrupt bonds overall despite the complex and lengthy nature of bankruptcy proceedings the results support efficiency the finance literature has traditionally assumed that when a firm enters bankruptcy the creditors become the owners and the value of the firm is distributed according to the absolute priority rule apr the apr states that senior creditors should be fully compensated before junior creditors receive any portion of the bankrupt firm s value and junior creditors should receive full payment before shareholders receive any compensation in practice formal bankruptcy proceedings are complex processes that often violate the apr brown 1989 captures some of the intricacies of this process in a game theoretic model showing that the solution to the bargaining process in bankruptcy can involve deviations from the apr although the solution

stochastic dominance decision rules when the attributes are utility independent in multivariate decisions under risk assessing the complete utility function can be a major obstacle decision rules are investigated which characterize uniformly better alternatives with respect to a whole class of utility functions in this paper independence assumptions are imposed on the preference structure while the levels of attributes may be stochastically dependent in an arbitrary way the utilities considered are additive multiplicative or multilinear necessary and sufficient conditions are developed for uniform decisions over utilities with common substitutional structure and where the univariate conditional utilities show qualitative properties such as risk aversion the rules are direct extensions of known univariate rules and easy to evaluate

on option pricing bounds the purpose of this article is to compare the perrakis and ryan bounds of option prices in a single period model with option bounds derived using linear programming it is shown that the upper bounds are identical but that the lower bounds are different a comparison of these bounds together with merton s bounds and the black scholes prices in a lognormal securities market is presented the black scholes 1 option pricing model is preference free its simplicity derives from the continuous trading assumption which enables a portfolio of stock and bonds to be constructed so as to replicate the payouts of the option in an incomplete market with only finite opportunities to revise portfolios no preference free option price can be constructed 3 6 for this case preferencedependent prices can be established rather than place restrictive assumptions on preferences perrakis and ryan pr 5 have recently derived upper and lower bounds for a single and multiple period call option price the development of these bounds is based on the single price law and arbitrage arguments and requires modest assumptions on preferences the bounds exist as equilibrium values given a consensus on stock price distributions in this article we shall develop bounds for option prices based on primitive prices in incomplete markets and compare these bounds to the single period bounds derived by perrakis and ryan towards this goal we first review the pricing approach for primitive securities and proceed to re express the pr bounds as derived from their arbitrage portfolios then using linear programming bounds on option prices are derived linear programming approaches for obtaining relationships among option prices have been investigated garman 2 for example established an algebra for evaluating hedge portfolios using this algebra a one period linear program can be established that provides a way to search for arbitrage opportunities over an infinite number of portfolio strategies one of the features of the algebra is that only one linear program need be solved to determine if riskless arbitrage strategies can be established by investigating the dual of the linear program garman obtained necessary and sufficient conditions for rational option pricing in a one period setting these bounds were shown to be consistent with the bounds determined by merton 4 unlike garman s approach the linear programming approach presented here places constraints on time preferences risk aversion and state probabilities under specific sets of assumptions linear programs are formulated where the objective function to be optimized is the call price minimization and maximi

the effect of commute time on racial earnings inequality a case study of the houston metropolitan statistical area data from the united states census confirm a substantial increase in the racial earnings gap between 1980 and 1990 this paper examines data on whites and non white wage and salary incomes in houston tx for 1980 and 1990 data on time travelled to work is used to simulate what would be the impact of shorter commute times on earnings inequality the central finding is that a reduction in travel time from residence to work would cause a very small reduction in racial earnings and income inequality this suggests that advances in urban transportation policy alone are not sufficient to solve the problem of racial earnings inequality

market based empirical research in accounting a review interpretation and extension a decade and a half of the most concerted and ambitious research effort in accounting history is evaluated here it is the search into the relationship between publicly disclosed accounting information and the consequences of the use of this information by the major group of usersequity investors as such consequences are reflected in characteristics of common stocks traded in major exchanges this research effort known as market based accounting research mbar obtained its impetus from major developments in finance theory during the late 1950s and early 1960s these were the portfolio selection theory and its offspring the capital asset pricing model capm and the concept of informationally efficient capital markets ecm subsequent developments in information economics agency theory and optimal incentive signaling models were quickly incorporated into mbar while the impetus to this line of research came from other disciplines accounting was not only a beneficiary but also to a modest extent a benefactor mbar is relevant to the study of capital market efficiency the capm information economics and regulation this contribution distinguishes mbar from most accounting areas whose contributions to other disciplines are negligible in

convergence across the swedish counties 1911 1993 abstract this paper finds strong and robust evidence of convergence in per capita income across the twenty four swedish counties 1911 1993 in contrast to most previous studies on regional convergence this study adjusts incomes to account for regional differences in the cost of living the main conclusion is that using adjusted incomes as opposed to non adjusted incomes does not qualitatively change the results on convergence for the swedish counties however a quantitative difference is that estimated speeds of convergence are higher and the standard deviation of the log of per capita income is lower when adjusted incomes are used which is consistent with cross country evidence

economic growth and convergence in latin america little is known about the convergence process among developing countries in general and in latin america in particular for the period as a whole there is no evidence of a narrowing in the cross country dispersion of income sigma convergence but there is evidence of convergence to different steady state income levels at a speed that is common to all countries conditional beta convergence the article also shows that the estimates of convergence are sensitive to the way in which gdp per capita is measured

ranking occupations as risky income prospects this study investigates the problem of how best to measure the income attractiveness of various occupations allowing for the differences among occupations in their stability of income analyzing data for eleven occupations from the one percent public use sample of the 1970 u s census of occupations the authors demonstrate the weaknesses of measures used in previous studies and the advantages of using stochastic dominance analysis

convergence and divergence in latin america 1970 1998 this paper examines the process of convergence in latin america over the period 1970 1998 there has been relatively little work on income convergence among developing countries in general and in latin america in particular even though many studies have examined convergence both within and among developed countries there is little support for the convergence hypothesis over the sample period as a whole although the beta coefficient is positive it is insignificant convergence is strong in the 1970s but by the 1990s it has disappeared there is no evidence of a narrowing in the cross country dispersion of income sigma convergence for the sample period as a whole the results offer little support for the neo classical growth model poorer countries have not grown faster than richer ones there is a strong case for strengthening regional development policy

regional welfare disparities the case of the european union the regional welfare distribution in the european union between 1993 and 1998 is examined using several complementary methodologies the results obtained show a reduction in regional welfare disparities over the period analysed it is worth noting in this respect however that regional productivity differences prove to be the main determinant behind observed welfare inequality in the european context moreover there has also been a decline in regional bipolarization over the six year contemplated while the degree of observed intradistributional mobility is relatively low the empirical evidence presented nevertheless reveals the importance of variables such as the national component the spatial location the regional productive structure or the percentage of gdp devoted to investment or to r d expenditure in accounting for the dynamics of the distribution under analysis

the effects of shifts in a return distribution on optimal portfolios when the distribution of the returns of a risky asset undergoes a stochastically dominating shift a risk averse investor may not necessarily increase the investment in that asset this paper provides restrictions on the investor s utility function that are necessary and sufficient for a dominating shift to bring about no decrease in the investment in the respective asset if there are two risky assets in the portfolio these conditions are also necessary if there are n 2 assets and are necessary and sufficient if the utility function exhibits constant absolute risk aversion copyright 1990 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

a stochastic dominance comparison of water conserving irrigation strategies stochastic dominance and stochastic dominance with respect to a function are used to compare water conserving irrigation strategies in an area of declining ground water supplies a computerized grain sorghum plant growth model using daily weather observations provides the basis for stochastic dominance comparisons six irrigation strategies dominate contemporary intensive irrigation practices by first degree stochastic dominance and two additional strategies exhibit second degree stochastic dominance over contemporary practices dominant strategies involve irrigating based on a 45 percent soil water criterion and eliminating early season irrigations some dominant strategies reduce water use by as much as 40 percent while increasing expected net returns

the use of risk and return models for multiattribute decisions with decomposable utilities normatively oriented approaches to decision making under uncertainty occupy a major portion of the literature of decision analysis among the proposed approaches the von neumann morgenstern expected utility eu theory has been the most prominent model of rational choice despite some controversies that surround this model with respect to its descriptive ability as well as the plausibility of utility assessment in actual decision situations 6 10 although most applications of the eu model have been concerned with decisions involving monetary outcomes its scope is not limited to any particular class of conse quences the basic appeal of the model is attributable partly to its generality in this regard and more importantly to the apparent reasonableness of its preferentialaxioms in the context of decisions with monetary outcomes several alternatives to the eu model have been proposed including the mean variance and mean semivariance models that have found popularity in the economies and finance litera ture see 4 8 and 9 in contrast to the eu theory where a decision maker s preferences among uncertain prospects are assumed given preferences in these models are formulated in terms of two attributes that are presumed to character ize all available choices in the mean semivariance model for example uncer tain prospects are viewed entirely in terms of their means and below target semivariances a generalization of this model was examined by fishburn 2 who showed that the general mean risk model exhibits a certain degree of compatibility with the eu model more recently holthausen 5 showed that this compatibility is significantly enhanced when mean is replaced by a return measure de fined as a probability weighted function of above target deviations specifically holthausen proved that this model yields the same preferences as the eu model whenever the expected utility function has the form

an empirical analysis of term premiums using stochastic dominance abstract this paper examines term premiums in u s treasury bill monthly holding period returns several techniques are employed to ascertain whether the observed term premiums are economically meaningful no second order stochastic dominance is found in the first five month maturities when a riskless asset is assumed the first two maturities are dominated therefore we conclude that although there are statistically significant term premiums they are not economically meaningful if there is no riskless borrowing and lending the term premiums are economically meaningful in the sense that the longer maturities dominate the shorter maturities when a riskless asset is available

stochastic dominance vs mean variance portfolio analysis an empirical evaluation most of the work in portfolio theory in the past decade has been based on the principle of utility maximization where either the investor s utility function is assumed to be a second degree polynomial with a positive first derivative and a negative second derivative or the probability functions are assumed to be normal if at least one of these conditions holds it can be shown that choosing among risky assets on the basis of their mean and variance only is consistent with the von neumann morgenstern utility maximization model thus given the above assumptions the incorporation of higher moments of a distribution and the adoption of alternative approaches to portfolio selection have largely been ignored in favor of the more familiar mean variance approaches

market reaction to quarterly earnings announcements a stochastic dominance based test of market efficiency the use of the capm in empirical research is subject to some criticism in light of this criticism the stochastic dominance criteria are offered as an alternative research method for the examination of market efficiency the underlying assumptions of the two frameworks are discussed and the stochastic dominance technique is demonstrated via the examination of market reaction to quarterly earnings announcements during the 24 quarters commencing with october 1962 the findings are compared to those of watts watts r the time series behavior of quarterly earnings unpublished paper university of newcastle newcastle n s w 1975 quoted in watts 1978 who utilized the same data base in contrast to watts conclusion our analysis suggests that the market was efficient during the entire period examined and that no significant differences in market behavior between the first and the second 12 month periods was evident the discord may be attributed to the relative effectiveness of the two analytical tool

foundations of decision analysis along the way this paper offers a personal perspective on the development of decision theory and related subjects during the past half century it first reviews six milestones in the foundations of decision analysis that are associated with frank p ramsey john von neumann and oskar morgenstern leonard j savage maurice allais and ward edwards west churchman and russell ackoff and kenneth arrow it then gives a personal account of further developments over the past 30 years in linear utility theory subjective probability and ambiguity nonlinear preference and utility stochastic dominance and inequality analysis multiattribute utility theory and the theory of social choice the paper could be viewed as a supplement to my extensive review of utility theory in management science some 20 years ago however it makes no claim of completeness since its main aim is to recall important debts and describe what it has been like to be a part of the development of decision analysis in the past few decades

option bounds in discrete time extensions and the pricing of the american put in a recent paper perrakis and ryan 1984 upper and lower bounds on european option prices were derived in discrete time these bounds were based on an extension of the discrete time derivation of black scholes pricing first presented in the work of black and scholes 1973 the bounds are functions of the stock and exercise prices the riskless rate of interest the time to maturity and the entire distribution of stock returns in other words they need more information than black scholes for their computation and the derived results are weaker on the other hand they are significantly more general in their assumptions insofar as they do not rely on the continuous time riskless hedge of the original black scholes derivations or on the assumption of a binomial distribution of stock returns used in cox ross and rubinstein 1979 and rendleman and bartter 1979 for this reason they are likely to be particularly useful in valuing options on assets for which the black scholes methodology is clearly this paper generalizes and tightens the discrete time bounds for european options and develops similar bounds for american puts the stock return has a distribution with a finite range and is subject to the restriction that the stock be nonnegative beta the bounds are derived from arbitrage portfolios using the stock the option and the riskless asset they converge to the previous ones when the range coincides with the nonnegative real line and they both become equal to the binomial option model under a two state stock return upper and lower bounds for the american put are derived recursively by the same method with arbitrage portfolios involving the stock the riskless asset and american and european puts an example is provided with a trinomial return distribution part of this research was done while i was a visiting professor 1983 84 ecole superieure de commerce et d administration des entreprises reims france i wish to thank peter ryan albert madansky and a referee of this journal for helpful advice and comment while retaining all responsibility for any remaining errors or omissions 1 note however that this is also true of other blackscholes generalizations such as merton 1976

ordering uncertain options under inflation a note stochastic dominance rules sd have been extended to the case where investors are allowed to borrow and lend at the riskless interest rate stochastic dominance rules with a riskless asset sdr are much more effective than sd rules however it seems that this benefit is eliminated by an uncertain inflation since riskless assets become risky once uncertain inflation is considered we prove in this paper that sdr criteria are valid also in the face of uncertain and independent inflation moreover while the mean variance mv efficient set increases with uncertain inflation the stochastic dominance efficient sets decrease stochastic dominance criteria sd for ordering risky assets were developed mainly in the late sixties following the development of the mean variance rule mv and the capital asset pricing model capm by analogy to the extension of sharpe and lintner of the mv criterion levy and kroll 10 have extended the sd rules by allowing borrowing and lending at the riskless interest rate this extension sharply decreases the size of the efficient set and in some cases an empirical separation is obtained or almost a separation where the efficient set of risky assets includes only one or two risky portfolios see levy and kroll 11 note however that these important economic results rely on the assumption that a riskless asset indeed exists an assumption which cannot be defended in a period of uncertain inflation chen and boness 2 roll 17 and friend et al 5 investigate the impact of inflation on the capm chen and boness assume a quadratic utility function and also make the assumption that the real rate of return is given by the nominal rate of return less the inflation hence ignoring the cross product of inflation and rates of return which greatly simplifies the mathematical analysis roll also assumes a quadratic utility function and further makes the assumption that a riskless asset in real terms exists friend et al assume that returns are generated by a wiener process the investment horizon is infinitesimal and that investors are characterized by constant proportional risk aversion under these assumptions they derive a formula which is analogous to the capm where inflation a random variable is incorporated in the formula it should be noted that by an infinitesimal investment horizon they do away with the cross product of inflation and the rates of return which is equal to zero in this specific case the relationship between the inflation rate and stock prices has been a subject

the systematic risk of corporate bonds this statement presents the usual perception of bond risk it is striking in that it does not discuss what is from a portfolio theoretic view the risk of a bond the covariance of its return with the returns of other assets this is in contrast to the typical discussion of the riskiness of common stocks where we find some discussion of systematic risk and the role it plays in determining equilibrium expected security returns

distributional analysis of portfolio choice trading in a market is compared with receiving some particular consu mption bundle given increasing state independent preferences and complete markets the analysis focuses on the distribution price of t he particular bundle the distributional price is the price of the ch eapest utility equivalent bundle sold in the market the distribution al price is determined by the distribution functions of the outside b undle and the state price density simple portfolio performance measu res illustrate the value of the approach unlike capm based measures these measures are valid even when superior information is the sourc e of superior performance copyright 1988 by the university of chicago

the risk return attributes of publicly traded venture capital implications for investors and public policy abstract despite having provided original seed money to extremely successful start ups such as federal express cray research and apple computer the small business administration sba with encouragement from the u s senate has recently placed a moratorium on granting new small business investment company sbic licenses and due to perceived fund mismanagement at least some senators have suggested that the misguided sbis could lead to a mini s l bailout consequently the sba has threatened the existence of the sbic government assisted program two public policy issues arise first should the government sponsor sbics given their past risk return characteristics second if sba support does re emerge should changes be made to the organizational structure of sbics with respect to the first issue our study examines the risk return attributes of two categories of venture capital funds publicly traded business development corporations bdcs and sbics popular folklore as well as a recent study in this journal suggest that a well diversified fund of venture capital containing both sbics and bdcs outperforms the general market while previous research assumes that sbics are similar to bdcs we find striking dissimilarities between these groups during 1980 1986 sbics demonstrate significantly greater total and unsystematic risk but significantly less systematic risk than bdcs in addition sbics experience much higher returns on a risk adjusted basis than either the market proxy or bdcs financial theory suggests a number of reasons for the differential performance among the two groups moreover given the strong investment successes of publicly traded sbics during the early to middle 1980s and the ability of the public to monitor sbic investment in lieu of the sba we conclude that continued sba financing of sbics benefits the investment community however the investment performance of sbics in the late 1980s contrasts with the successes achieved earlier in the decade since 1986 many publicly traded sbics have performed poorly liquidated or changed their organizational status we conclude that many of these problems originate with the investment company act of 1940 this act limits operating flexibility of sbics discourages public trading and related monitoring by public investors and reduces the equity capital cushion accordingly we propose guidelines including audit and equity capital considerations that may mitigate difficulties stemming from the organizational structure of sbics public policy issues related to sba sponsorship of sbics are relevant to individual and institutional investors particularly as they relate to dividends liquidity investment allocation and portfolio risk of venture capital related funds for example our study indicates that publicly traded sbics on average appear to have greater corporate financial leverage and a large percentage of their portfolio invested in fixed income securities compared with private sbics which invest more heavily in equity funds to the extent that the sba relaxes dividend payout restrictions on sbic operating income we might expect lower financial leverage and a greater portfolio allocation to equity instruments this change would tend to reduce the financial risk related to sbic ownership and encourage the provision of equity capital to emerging enterprises

the value of commuting time in an empirical on the job search model an application based on moments from two samples this article estimates the value of commuting time voct among swedish males in an empirical on the job search model it uses a large sample of employee establishment linked data obtained from administrative registers the sample lacks information on mode choice for the journey to work we therefore estimate a mode choice model on another sample and use this model to link the administrative data to the relevant set of travel times costs and distances the voct is found to be 1 8 times the net hourly wage rate in the sample the relatively high estimate results from a high voct among cohabiting men

mean gini portfolio theory and the pricing of risky assets this paper presents the mean gini mg approach to analyze risky prospects and construct optimum portfolios the proposed method has the simplicity of a mean variance model and the main features of stochastic dominance efficiency since mean gini is consistent with investor behavior under uncertainty for a wide class of probability distributions gini s mean difference is shown to be more adequate than the variance for evaluating the variability of a prospect the mg approach is then applied to capital markets and the security valuation theorem is derived as a general relationship between average return and risk this is further extended to include a degree of risk aversion that can be estimated from capital market data the analysis is concluded with the concentration ratio to allow for the classification of different securities with respect to their relative riskiness

geometric mean approximations in 1959 henry latana 2 proposed an approximation to the geometric mean that was a simple function of the arithmetic mean and variance thereby indicating a mathematical relationship between the risky investment choice model of bernoulli and the markowitz mean variance model in 1969 young and trent 4 presented empirical test results of the latane approximation as well as a set of other approximations to the geometric mean based on moments and concluded that the latane formula yielded a quite accurate approximation to the geometric mean in jean s 1980 paper 1 relating the geometric mean model to stochastic dominance models the infinite series representation of the geometric mean used suggests a more accurate approximation with moments of the geometric mean than that contained in the earlier papers may be possible various forms of that series expressed in alternate origin moments are tested empirically below and the results confirm that this later series does yield the greatest accuracy of the three approaches

the relationship between arbitrage and first order stochastic dominance this paper joins together two fields of research in financial economics the first field studies stochastic dominance while the second field studies arbitrage pricing the two fields are linked together through the derivation and the proof of a characterization theorem the characterization theorem gives necessary and sufficient conditions for the existence of arbitrage opportunities in terms of the existence of two assets one of which first order stochastically dominates the other and the price of a particular contingent claim examples are provided to demonstrate the theorem s content this paper joins together two fields of research in financial economics the first field studies portfolio choice from the perspective of stochastic dominance see hadar and russell 5 6 hanoch and levy 7 levy and kroll 13 the second field studies arbitrage pricing its characterization and implications see ross 15 kreps 12 harrison and kreps 8 harrison and pliska 9 in these fields it is well known that the existence of arbitrage opportunities implies first order stochastic dominance and that the converse does not hold this paper provides a set of conditions under which the converse is true given complete markets the existence of an arbitrage opportunity is characterized in terms of the existence of two traded assets one of which stochastically dominates the other along with one additional condition the additional condition is roughly that state contingent prices must be zero over the states where the first asset dominates the second the theorem has a qualification however it is applicable only in markets which are complete not in the arrow debreu sense but in a weaker sense in the sense that all contingent claims on the primary assets must trade in many applications especially with respect to continuous trading models this condition is usually satisfied see duffie 2 and harrison and pliska 9 in the case of stochastically dominated assets this paper shows that the relationship of the assets to the state contingent prices is important in identifying arbitrage opportunities in this sense this paper is related to a recent paper of jagannathan 10 jagannathan studies the relationship of second order stochastic dominance not first order to call option valuation this characterization theorem relating arbitrage opportunities to stochastic dominance should provide a valuable tool in the area of stochastic dominance this theorem specifies conditions under which two assets can be compared using first order stochastic dominance on an individual basis for inclusion in the

third degree stochastic dominance here f x and g x are less than cumulative probability distributionis where x is a continuous or discrete random variable representing the outcome of a prospect the closed interval a b is the sample space of both prospects the integral shown in rule 2 and those shown throughout the paper are stieltjes integrals recall that the stieltjes integral fb f x dg x exists if one of the functions f and g is continuous and the other has finite variation in a b let d1 d2 and d3 be three sets of utility functions x d1 is the set containing all utility functions with 4 x and 1 x continuous and 41 x 0 for all xe a b d2 is the set with x 1 x 2 x continuous and q j x 0 02 x o for all xc a b d3 is the set with x 1 x 2 x 3 x continuous and 1 x 04 2 x o o for all xc a b here 1 x denotes the ith derivative of x hadar and russell proved that rule 1 is valid for all cd1 and rutle 2 is valid for all ed2 the authors point out that the set of probability distributions that can be ordered by means of second degree stochastic dominance is in general larger than that which can be ordered by means of first degree stochastic dominance note that in rule 2 they assume that x is not only an increasing function of x but also exhibits weak global risk aversion a condition guaranteed by requiring the second derivative of x to be nonpositive in this paper a condition which will be called third degree stochastic dominance is considered it is based on the following assumption about the form of the utility function x from a normative point of view one expects the risk premium associated with an uncertain prospect to become smaller the greater is the individual s wealth the plausibility and implications of this assumption h ave been explored by john pratt as well as others the risk premium of an uncertain prospect is that amount by which the certainty equivalent of the prospect differs from its expected value in mathematical terms given the prospect f x with expected value a the corresponding risk premium t is obtained by solving the following equation rb

corporate bond price data sources and return risk measurement to date a number of studies involving the use of bond prices and or returns have utilized the published prices of trades on the new york and other exchanges these exchange quotes reflect the odd lot activities of individual investors and account for only a negligible portion of the trading in listed issues in contrast the vast majority of listed corporate trading occurs over the counter and involves round lot trades between institutions given differences in market characteristics odd lot exchange prices may differ substantially from those in the round lot institutional market this study compares exchange quotations from moody s bond record with prices assigned by merrill lynch s institutional pricing service and uses each set of prices to calculate return and risk measures institutional merrill lynch bond prices are shown to be systematically greater than exchange moody s prices in addition bond returns based on merrill lynch prices are shown to yield significantly higher beta and r 2 estimates as well as significantly lower standard deviation and residual risk estimates

multivariate decision making abstract consider a set of multivariate risky options a partial ordering of these options is quite difficult and even for the two dimensional case a knowledge of the cross derivatives of the decision maker s utility function is required in this paper we establish first degree multivariate stochastic dominance by applying the concepts of the indirect utility function and the indirect probability distribution thus we reduce the complex multivariate risky option into a univariate risky option where the random variable is the derived indirect income the second degree stochastic dominance rule is also derived under certain restrictions on the utility function

option pricing bounds in discrete time upper and lower bounds are derived for call options traded at discrete intervals these bounds are independent of assumptions on the stock price distribution other than a restriction satisfied by the stock being non negative beta the development of the bounds relies on the single price law and arbitrage arguments both single period and multiperiod results are produced and put option bounds follow by extension the bounds exist as equilibrium values given a consensus on stock price distribution they are also valid for empirical studies being adjustable for dividends and commissions following the impetus of the black scholes pricing model the majority of option analyses have been in continuous time such approaches have relied on the formation of perfect riskless hedges involving the option its underlying security and a riskless asset since the hedge must be continuously revised and maintained while actual trading opportunities are discrete this crucial assumption limits the accuracy and applicability of the black scholes and related formulae in fact the black scholes formula can only be considered as a valid approximation to the discrete time solution merton 8 p 663 while the closeness of that approximation has not been ascertained in general 1 earlier discrete models such as boness 3 and samuelson 12 have been succeeded by those of brennan 5 cox et al 6 and rubinstein 11 in which distributional restrictions are imposed on share returns usually the discrete formula converges to the black scholes expression under appropriate limit conditions using the rubinstein 11 approach we derive upper and lower bounds for option prices with both a general price distribution and discrete trading opportunities the bounds are functions of the share and exercise prices the riskless rate of interest the distribution of the share price change per period and the number of periods of expiration of the option the lower bound is tighter than that of merton 7 derived from more general arbitrage considerations while being less exact than the results already mentioned for restricted distributions

stochastic dominance and expected utility survey and analysis while stochastic dominance has been employed in various forms as early as 1932 it has only been since 1969 1970 that the notion has been developed and extensively employed in the area of economics finance agriculture statistics marketing and operations research in this survey the first second and third order stochastic dominance rules are discussed with an emphasis on the development in the area since the 1980s

agency theory and stochastic dominance 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

convergence and divergence in regional household incomes per head in the united kingdom 1984 93 this paper examines the convergence of regional household incomes in the uk and finds support for the idea that regions in the uk have in the recent past tended to diverge during booms and converge during slumps a new way of presenting the change in the distribution of regional incomes is offered the results are extended to the consideration of movements in the higher moments of the underlying distributions

regional mobility in the european union regional mobility in the spatial distribution of per capita income in the european union is examined over the period 1977 to 1999 the methodology used to investigate this issue combines a series of measures taken from the literature devoted to the dynamic study of personal income distribution with a non parametric analysis the results show limited mobility in the distribution considered and a decline in mobility over time the empirical evidence presented indicates moreover that mobility patterns vary as a function of regional development levels additionally the analysis carried out investigates the role played in explaining intra distribution mobility by variables such as per capita income population density per capita expenditure in investment market potential and the share in total employment of agriculture advanced services and non market services

on stochastic dominance and decreasing absolute risk averse option pricing bounds merton perrakis and ryan levy and ritchken have established option pricing bounds under first and second stochastic dominance preferences these bounds are particularly important for valuing contingent claims when continuous trading in the claim and or underlying security does not exist this article provides option bounds under higher orders of dominance specifically option bounds are obtained by solving mathematical programs where preference structures on prices are represented by constraints for first second third and higher orders of stochastic dominance preferences the special linear structure of the mathematical programs allow analytical solutions to be obtained for the bounds for dara preferences third order stochastic dominance while being necessary is not sufficient and additional constraints must be imposed unfortunately these additional constraints are nonlinear while in this case closed form analytical solutions for the option bounds are not obtained numerical examples are presented to illustrate their strength

some results on bond yield and default probability fisher 5 suggested that the difference between a corporate bond s promised yield tomaturity ytm and the ytm of a government bond of the same maturity is composed of the sum of the corporate default risk the variability of the firm s earnings the firm s reliability in meeting its obligations its capital structure and the bond s marketability since then fisher s measure has often been used to measure bond risk for example fraser and mccormack 6 have used the spreads between newly issued bank bonds and aaa bonds of compatible maturities as substitutes for riskless government bonds to measure the changes in banks borrowing risk after two large bank failures in their paper spread is intended to provide for intra firm industry default risk comparisons over time radcliffe 15 uses yield spreads to differentiate the riskiness among corporate bonds in this case the spread is used for inter firm risk comparisons sharpe 18 has suggested a similar measure of bond default risk which is the ytm less the expected rate of return however most of these papers do not provide a bond pricing model which would furnish the link between a firm s riskiness and the ytm and default risk of its bond without this it is difficult to draw inferences between ytm s and default risk

comparison of alternative utility functions in portfolio selection problems this paper examines the effect of alternative utility functions and parameter values on the optimal composition of a risky investment portfolio normally distributed assets are the setting for the theoretical and empirical analyses the results agree well with the available theory and imply utility functions and parameter values that are appropriate for investors with particular risk bearing attitudes the results give strong empirical support to the proposition that utility functions having different functional forms and parameter values but similar absolute risk aversion indices have similar optimal portfolios these results suggest that over horizons up to one year one can safely substitute convenient surrogate utility functions for other utility functions for reasons of tractability or otherwise the results also provide guidance regarding the significance of the magnitude and change of particular numerical values of the risk aversion index moreover theoretical exact results are obtained using rubinstein s measure of global risk aversion

demand for risky financial assets a portfolio analysis abstract demand for risky financial assets takes place in portfolio settings the common stochastic orders applied in economics fail to rank demand for assets in such situations even for risk averse investors therefore the evaluation of the relative desirability of risky financial assets requires the establishment of new orders we prove that if returns on risky assets are ordered by the monotone likelihood ratio order then dominating assets will be more desired by all investors with nondecreasing utility functions

choice under uncertainty problems solved and unsolved ffifteen years ago the theory of choice under uncertainty could be considered one of the success stories of economic analysis it rested on solid axiomatic foundations it had seen important breakthroughs in the analytics of risk risk aversion and their applications to economic issues and it stood ready to provide the theoretical underpinnings for the newly emerging information revolution in economics 1 today choice under uncertainty is a field in flux the standard theory is being challenged on several grounds from both within and outside economics the nature of these challenges and of our profession s responses to them is the topic of this paper

stochastic dominance and the investment horizon with riskless assets this paper analyses the relationship between the efficient sets of investment portfolios and the investment holding period investors are allowed to hold risky assets as well as the riskless asset the main result is that dominance in each period implies dominance in the multiperiod case this finding holds with respect to first second and third degree stochastic dominance the riskless interest rate may vary from one period to another without changing the results of this paper

bond systematic risk and the option pricing model in this paper we examine the behavior of the systematic risk of corporate bonds a model that assumes d is constant is compared with a model that allows systematic risk to vary in a manner consistent with the black scholes merton options pricing model this procedure captures some fundamental properties of the movement of bond b and provides a starting point for improved models of the process generating bond returns a number of recent papers have shown that the systematic risk of corporate bonds is related to bond rating in this paper a model of the relation between the systematic risk of a bond customarily denoted b and the characteristics of the bond the issuer and the state of the capital markets is formulated and subjected to the empirical test the empirical analysis differs from the studies cited earlier in that the estimation technique explicitly allows for nonstationarity of b the paper is organized in the following manner a general market model regression with nonstationary coefficients is introduced in section i section i also shows how the black scholes merton option pricing model can be used to make predictions about the regression coefficient or b of corporate bonds section ii describes the methods and data used in the tests section iii presents the results and section iv contains a summary and suggestions for future research

mean lower partial moment valuation and lognormally distributed returns in this paper we develop a capital asset pricing model in a mean lower partial moment framework specifically we show that when partial moments are computed about the expected risky portfolio return optimal portfolio choice in a mean lower partial framework permits a two fund portfolio separation between a riskless asset and a market portfolio of risky assets in this new framework risk is measured as semideviation for second degree stochastic dominance and semivariance for third degree stochastic dominance further when security returns are lognormally distributed and small risk this new mean lower partial moment valuation specializes to the mean logarithmic variance capital asset pricing model

time varying return and risk in the corporate bond market this paper examines the pricing of exchange traded long term corporate bond portfolios observable instruments measuring the term structure of interest rates levels of bond and stock prices and a january dummy are found to predict excess returns on corporate bonds an intertemporal asset pricing model with changing expectations and unobservable factors is then estimated for the predictable excess returns using hansen s generalized method of moments the results show that a multibeta linear time varying model of con ditional expected returns with constant betas can successfully value corporate bonds spe cifically the tests indicate the presence of two time varying hedge portfolios the data however support a single latent variable specification when all january observations are excluded this result suggests the existence of a strong january seasonal in one of the latent variables

aggregate economic fluctuations and regional convergence the finnish case 1988 95 this paper analyses the connection between aggregate economic fluctuations and regional productivity convergence in finland during the period 1988 95 markov chain transition matrices and mobility indices were used to examine the regional distribution of productivity the results indicated that high intra distribution mobility occurred during booms when regional convergence potential was also at its highest conversely recession years were characterized by much lower mobility and a more divergent regional pattern these findings bear important implications in terms of regional policy planning as it seems that poor regions do not manage to keep up with the rich ones during slumps whereas regional disparities diminish naturally during boom years

stochastic dominance and expected utility while stochastic dominance has been employed in various forms as early as 1932 it has only been since 1969 1970 that the notion has been developed and extensively employed in the area of economics

asset proportions in optimal portfolios the paper is concerned with conditions under which the proportion of a given asset in the optimal portfolio of a risk averse agent is at least as large as some given proportion the paper provides a condition that is necessary and sufficient for such a result to hold the analysis is then confined to portfolios in which the distributions of assets differ by either a first degree stochastic dominance shift or by a mean preserving shift examples are provided to show that under some conditions a risk averter may invest a smaller proportion of his wealth in the dominating asset than in the dominated asset the paper then provides conditions that are necessary and sufficient for a risk averter to invest more in the dominating asset the question of whether risk averse agents should or should not choose diversified portfolios as opposed to specialized ones has been analysed quite extensively in the literature examples of such works are samuelson 1967 brumelle 1974 hadar and russell 1974 russell and seo 1979 hadar and seo 1980 and macminn 1984 what has not been examined at all except for very special cases is the question of the optimal proportions of the various assets in a diversified portfolio in this paper we present conditions which imply that the optimal amount invested in a particular asset is at least as large as some given proportion of the available fund in the case of two asset portfolios one may especially want to know which of the two assets represents more than half the investible fund indeed we find it convenient to start the analysis with the two asset case while the extension to n asset protfolios is essentially straightfoward it is presented in a subsequent section focusing first on the two asset case will make it easier for the reader to see the main logical steps in the proofs of the theorems some of our analysis is facilitated by the use of a particular subset of risk averters this subset has the property that if its members behave in a particular way then all risk averters behave in that way we refer to such a subset as a representative set of all risk averters 2 the usefulness of the representative set derives from the fact that its members have utility functions of a very simple form consisting of two linear pieces and its applicability to the problems on hand derives from the fact that any concave function can be approximated by a linear combination of members of the representative set in the next section we present some formal results demonstrating the equivalence of unanimity among members of the representative set and unanimity among all risk averters in certain types of choice situations these theorems are then used in section 3 in which we present the results about optimal asset proportions

transfer principles in income redistribution abstract dalton s principle of transfer for income redistribution says that society will be better off when a unit of income in transferred from a richer to a poorer individual this paper investigates the conjunction of a natural extension of dalton s principle which says that any combination of a socially desirable transfer with its inverse at uniformly higher levels of income will have positive social benefit and a traditional utilitarian egalitarian formulation of social welfare the transfer principles involved in the extension of dalton s rule correspond to stochastic dominance relations between income distributions with a common mean and lead to the conclusion that when and g are income distributions the social welfare of is larger than that of g if e ax x ax g x for all positive a this conclusion is intimately connected with a measure of income inequality studied by kolm

stochastic dominance and uncertain price prospects since the seminal and simultaneous publications of hadar and russell 6 and hanoch and levy 8 there has been a virtual explosion of papers investigating implications of stochastic dominance rules for decisions under uncertainty dominance principles have important applications to portfolio choice capital budgeting and financial intermediation stochastic dominance can also be applied to investment and production decision problems under uncertainty in these areas both overall and marginal impacts of uncertainty have received wide attention 2 the emphasis in consumer welfare analysis under uncertainty has been on the ranking of different price prospects ranking of price prospects is more complicated than that of income prospects for two related reasons first due to differences in ordinal preferences among consumers the second degree stochastic dominance rule on price prospects does not yield a unanimous ranking among risk averse consumers thus waugh 17 massell 12 and samuelson 14 have focused on the ranking of price prospects for a single consumer or consumers with identical ordinal preferences second there is no a priori reason for income risk averse consumers to exhibit aversion to fair price risks specifically the indirect utility function of an income risk averse consumer is neither concave nor convex in prices indirect ways of comparing consumer welfare under alternative price prospects via expected consumer surplus expected compensating variation or expected equivalent variation have thus been investigated in the literature expected consumer surplus ecs has been particularly popular for ranking certain and uncertain price prospects 3 however turnovsky shalit and schmitz 16 showed that the ranking

an empirical comparison of stochastic dominance among lognormal prospects l introduct ion the theory of portfolio selection and diversification developed by markowitz 22 and tobin 33 was based primarily on the criterion of meanvariance mv efficiency the objective was to select an efficient set of portfolios from which every risk averter will choose the optimal portfolio which maximizes his expected utility the mv criterion is the appropriate rule either for the case in which the utility function is quadratic or if the returns are normally distributed and risk aversion is assumed two approaches to the choice among risky alternatives that have been developed independently over the past two decades are the geometric mean criterion gm and the stochastic dominance sd decision model both can be justified by the expected utility hypothesis with the geometric mean cri terion following as a result of the assumption that the decision maker has a logarithmic utility function and the stochastic dominance models requiring the less restrictive assumption of signs of the first few derivatives of the decision maker s utility function this paper compares the concept of ordinary stochastic dominance to stochastic dominance of the lognormally distributed prospects from an empirical point of view further 1ight is also shed on the issue of applying the markowitz tobin mean variance rule