Further Ambiguity When Performance Is Measured by the Security Market Line

This paper employs the optimality conditions for expected utility and mean-variance portfolio problems to examine the ambiguities associated with the security market line criterion both at a point in time and through time. At a point in time, we show that the security market line criterion can be irrelevant, even in meanvariance economies. In a multiperiod setting, we show that the analysis of performance based on portfolio choice is inconsistent with the analysis based on return generating models. Empirical work suggests that the inconsistency can lead to dramatically different estimates of a security's required return.     

Sharing rules and equilibrium in an international capital market under uncertainty

International capital market equilibrium is characterized for a world economy in which consumption preferences are defined multiplicatively over many commodities. It is shown that the set of relative asset prices under pure exchange in international capital markets depends on the real purchasing power of nominal payoffs under uncertainty and does not depend on the currency in which the nominal payoffs are denominated. A Sharpe-Lintner type international capital asset pricing model is derived as a special case. Proportional ad valorem commodity taxes and transportation costs are incorporated in the valuation model, interest rate parity and purchasing power parity are reinterpreted under uncertainty, and international differences in borrowing and lending are shown to reflect, in part, differences in risk aversion across countries.     

The unintended consequences of grouping in tests of asset pricing models

We identify a number of unintended consequences of grouping when the capital asset pricing model is true and when it is false. When the model is true, grouping may cause fundamental problems with the most basic capital asset pricing and cross-sectional regression relationships. For example, with traditional grouping, the market portfolio is super-efficient––unless securities in each group are value weighted. Yet, when the model is grossly false, grouping may cause the model to appear to be absolutely correct. Ironically, the only way this can occur is when securities in each group are value weighted. To make matters worse, when the model is false, the slope of a cross-sectional regression of expected returns on betas fitted to grouped data may be either steeper or flatter than when the regression is fitted to ungrouped data. In other words, grouping may exacerbate the very problem it was meant to alleviate.     

The Effectiveness of Social Media Storytelling in Strategic Innovation Communication: Narrative Form Matters

Storytelling is widely believed to be an effective strategy in innovation communication. The use of high-quality narratives in particular is recommended to facilitate the understanding of an innovation, facilitate trust in it, and promote the perception of innovative strength as well as the development of positive attitudes. However, to date virtually no empirical evidence has been presented to support these assumptions. Therefore, we conducted an experiment in which participants were exposed to messages about an innovation that varied in narrative quality (low vs. medium vs. high), and the messages were told in different forms that are typical of social media (nonserial vs. serial) to take account of the ever-increasing importance of these channels in innovation communication. The results show that the understanding of an innovation increases linearly with a message’s narrative quality, serial storytelling impedes understanding, and narrative quality is conducive to the attitude towards the innovator when the story is told in nonserial form and has a detrimental effect when told in serial form. Thus, the results show that the current view on storytelling’s potential is overly optimistic and that using high-quality narratives can, under certain conditions, also have adverse effects. The practical implications of these findings are discussed.     

Monetary rules and the nominal rate of interest under uncertainty

The expected real rate of return on a nominal bond is shown to be equal to the real rate of interest plus a premium for systematic purchasing power risk. The particular monetary rule employed by the central monetary authority affects the entire joint distribution of inflation and aggregate real wealth. Thus, the monetary authority is able to influence the relationship between the real and nominal interest rate not only by affecting the expected rate of inflation but also by affecting the systematic purchasing power risk of fixed nominal claims.     

Gains From Diversifying Into Real Estate: Three Decades of Portfolio Returns Based on the Dynamic Investment Model

This paper compares the investment policies and returns for portfolios of stocks and bonds with and without up to three categories of real estate. Both domestic and global settings are examined, with and without the possibility of leverage. The portfolios were generated via the dynamic investment model based on the empirical probability assessment approach applied to past (joint) realizations of returns, both with and without correction for "smoothing" in the real estate data series. Our principal findings are: (1) the gains from adding real estate, on a semi-passive (equal-weighted) basis, to portfolios of either U.S. or global financial assets were relatively modest; in contrast, (2) the gains from adding real estate to the universe of U.S. financial assets under an active strategy were rather large (in some cases highly statistically significant), especially for the very risk-averse strategies; (3) the gains from adding U.S. real estate to a universe of global financial assets under an active strategy were mixed, although generally favorable for the highly risk-averse strategies; (4) correcting for second-moment smoothing in the real estate returns series had a relatively small impact for the more risk-tolerant strategies; and (5) there was some evidence that desmoothing resulted in improved probability estimates.     

Cross-sectional tests of the CAPM and Fama–French three-factor model

Grouping does not produce a wide range of betas. Consequently, cross-sectional tests of the CAPM are bound to lack power. This paper provides a simple way to alleviate the problem by repackaging the data with zero-weight portfolios. When the CAPM is true and the data are repackaged, simulation shows that the average values of the intercept and slope converge to their true values more rapidly and there are striking increases in R² and the power of the tests. Empirical results are dramatically different in datasets with and without the zero-weight portfolios.     

Limiting losses may be injurious to your wealth

Theory tells us that if return distributions are independent over time, an expected utility maximizing logarithmic-utility investor will almost surely accumulate the most long-run wealth. This paper examines the robustness of the result. Specifically, it examines the expected and unexpected long-run and short-run consequences of imposing Value at Risk and other loss constraints on power-utility investors with a numerical example and empirically in an asset-allocation setting covering the 1934–2008 period. In addition, it examines the expected and unexpected long-run consequences of imposing Conditional Value at Risk constraints on power-utility and prospect-theory (kinked linear-utility) investors.     

Applying Portfolio Change and Conditional Performance Measures: The Case of Industry Rotation via the Dynamic Investment Model

This paper applies portfolio change and conditional performance measures to assess the performance of the dynamic investment model in various industry-rotation settings spanning the 1934–1995 period. The dynamic investment model employs the empirical probability assessment approach in raw form. In addition, it incorporates three adjustments for estimation error: James–Stein, Bayes–Stein, and CAPM-based corrections. The tests are unanimous in their conclusion that the excess returns attained by the (unadjusted) historic, the Bayes–Stein, and the James–Stein estimators are (sometimes highly) statistically significant over the 1966–1995 and 1966–1981 sub-periods. This lends support to the idea that the joint empirical probability assessment approach based on the recent past, with and without Stein-based corrections for estimation error, contains information that can be profitably exploited. The relationship of these findings to the extant literature on momentum and contrarian strategies is addressed.