A NOTE ON THE MARGINAL COST OF DEBT CAPITAL

The firms marginal cost of debt capital was interpreted in this author's previous publications as the "full marginal cost of relaxing the money capital availability constraint' when the incremental money capital employed takes the form of debt capital. Account is thereby taken of the effects on financing costs of the increased risk exposure that debt financing implies for both debt and equity holders. The present paper clarifies a misconception in a recently published paper by Draper and Findlay, and exhibits the linkage between concepts relevant to the firm's fmancing decision and the general marginal analysis.     

IS THE DISTRIBUTION OF BETAS STATIONARY?

The stationarity of the beta distribution for 1926–1985 is rejected for the entire period as a single sample. However, results for pairs of five-year estimation periods are more consistent with stationarity. Over all possible pairs of five-year periods, stationarity in the pair-wise tests is rejected more often than expected merely by chance. However, excluding two aberrant periods, the number of rejections of stationarity is consistent with chance. Therefore, the distribution of betas is nearly stationary in both the short run and long run. For practical purposes the distribution of betas may be regarded as stationary.     

ON VARIANCE AND LOWER PARTIAL MOMENT BETAS THE EQUIVALENCE OF SYSTEMATIC RISK MEASURES

The market equilibrium mean-lower partial moment (LPM) model may serve as an alternative to the traditional mean-variance (MV) CAPM for security analysis. It appears that the merits of the MV-CAPM vis-à-vis the mean-LPM model continue to be debated (see Nantell and Price, 1979; Price, Price and Nantell, 1982; and Homaifer and Gaddy, 1990). This paper demonstrates that from a theoretical perspective the two models are equivalent for general riskaverse investors. This modeling consistency is based on the fact that all return distributions which yield the mean-LPM equilibrium model must permit two-fund portfolio separation, and the well-known MV-CAPM is the direct pricing result of the two-fund portfolio separation. Hence any debate about the bias of systematic risk measures between the mean-LPM model and the MV-CAPM is meaningless. Nevertheless, although the economic equilibrium results of the models are identical, this does not indicate that the LPM portfolio theory is redundant or irrelevant. It may be that some behavioral perspective, sensitivity to downside risk is more appropriate than variance as a risk proxy.     

A PEDAGOGIC NOTE ON THE DERIVATION OF THE BLACK-SCHOLES OPTION PRICING FORMULA

This paper demonstrates an alternative derivation of the Black-Scholes option pricing formula based on the risk neutrality arguments of previous researchers. The underlying economic and mathematical structure of the formula is discussed.