Asymptotic distributions of the estimators of the Sharpe and Treynor performance measures are derived. Multivariate performance comparison measures, based on the traditional Sharpe and Treynor measures, are developed with their corresponding asymptotic distributions. The behavior of these new performance measures are evaluated in small samples. For single comparisons, a Sharpe z statistic is well behaved and for multiple comparisons a Sharpe chi-square statistic is reasonably well behaved. The powers of the tests are quite sensitive to the population coefficients of variation. Multivariate test statistics based upon the Treynor measure were not very satisfactory. THIS STUDY DEVELOPS SIGNIFICANCE tests of portfolio performance utilizing the Sharpe and Treynor measures. The approximate bias and asymptotic distributions of the estimators of the traditional Sharpe and Treynor performance measures are derived. Multivariate performance comparison measures based on these traditional measures are proposed for comparing the performance of n portfolios. The approximate bias and asymptotic distributions of the multivariate comparison measures are then derived and test statistics proposed. The behavior and usefulness of the statistics for hypothesis testing are evaluated in small samples with simulation experiments. We find that for single comparisons a z statistic based on Sharpe's measure is well behaved at small sample sizes although its power in detecting typical differences with monthly data is small. The z statistic, based on the Treynor measure, is not well behaved in small samples and also lacks power. For multiple comparisons a chi-square statistic, obtained from the Sharpe measures, is reasonably well behaved at small samples and its power increases as the number of portfolios increases and/or the coefficients of variation decrease. A chi-square statistic derived from the Treynor measure is not so well behaved. Section I of the paper discusses the availability of test statistics for various classes of performance measures. It also discusses the use of the Sharpe and Treynor statistics in light of certain undesirable properties they possess and the section concludes with a brief literature survey. Section II derives the performance measure moments, asymptotic distributions, and proposed test statistics. Section III contains the results and conclusions of the univariate and multivariate simul-ations.

https://www.jstor.org/stable/pdfplus/2327554.pdf

Performance Hypothesis Testing with the Sharpe and Treynor Measures

This paper explores the risk structure of interest rates. More specifically, we ask whether yields on industrial and commercial bonds indicate that market participants base their evaluations of a bond issue's default risk on agency ratings or on publically available financial statistics. Using a non-linear least squares procedure, we relate the yield to maturity to Moody's rating, Standard & Poor's rating, and accounting measures of credit worthiness such as coverage and leverage. We find that market yields are significantly correlated with both the ratings and with a set of readily available financial accounting statistics. These results indicate (1) that market participants base their evaluations of an issue's credit worthiness on more than the agencies' ratings and (2) that the ratings bring some information to the market above and beyond that contained in the set of accounting variables. In addition, our results suggest that the market views Moody's and S&P's ratings as equally reliable measures of risk. Although the accounting measures also affect yields on new or recently reviewed issues, our analysis suggests that the market may pay more attention to the accounting measures and less to the ratings if the rating has not been reviewed recently.

The Informational Content of Bond Ratings

This paper applies a contingent claims approach to examine the duration of a zero coupon bond subject to default risk. One replicating portfolio for a default-prone zero coupon bond contains a long position in the default-free asset plus a short position in a put option on the underlying assets. The duration of the bond is shown to be a weighted combination of the duration of the default-free bond and the put option. The duration is less than maturity and is not an immunizing duration. The technique is then extended to subordinated debt. DURATION IS A SUBJECT of much concern to researchers and bond portfolio managers. In the last five decades, the literature on duration has grown from a simple explication of its property as a measure of average maturity (Macaulay (1938)) to sophisticated strategies such as funding multiple liabilities (Fong and Vasicek (1984)). Duration, however, is not without its critics. For example, the simplest framework for a duration model, a world of parallel yield curve shifts, is not only an unlikely state of nature but is also inconsistent with equilibrium (Ingersoll, Skeleton, and Weil (1978)). Fortunately, however, Bierwag, Kaufman, and Toevs (1982) have shown that a given duration measure, even the simplest one, can be consistent with equilibrium, as well as disequilibrium, processes. Thus, it should not be too surprising that, in spite of its limitations, duration is still widely used today in bond portfolio management. Although progress and, in some cases, solutions have been developed for a number of practical and theoretical problems in duration, many remain unsolved. For example, the effect of default risk on duration is currently unknown. It hardly seems wise to assume that default-free duration strategies will be appropriate for default-prone markets. In a world of contingent claims contracting, however, investors can separate default effects from interest rate effects. Given the large size of the market for default-prone bonds, it is obvious, nonetheless, that many investors choose to accept both risks.1 Therefore, the extent to which default premia are affected by interest rates, and, thus, have a potential impact

Default Risk and the Duration of Zero Coupon Bonds

Purpose – The purpose of this paper is to investigate the effects of investment opportunities and corporate finance on dividend payout policy.Design/methodology/approach – This issue is tested with a sample of 34 emerging market countries covering a 17‐year period, 1990‐2006. Fixed effects panel model is employed in our estimation.Findings – A significantly negative relationship between investment opportunity set and dividend payout policy is found. There are, however, insignificant effects of the various measures of corporate finance namely, financial leverage, external financing, and debt maturity on dividend payout policy. Profitability and stock market capitalization are also identified as important in influencing dividend payout policy. Profitable firms are more likely to support high dividend payments to shareholders. However, firms in relatively well‐developed markets tend to exhibit low dividend payout policy.Originality/value – The main value of the paper is in respect of the fact that it uses a ...

Investment opportunities, corporate finance, and dividend payout policy: Evidence from emerging markets

The development of organized markets for speculative-grade corporate debt has provided financial researchers with an opportunity to examine the pricing of default risk. By incorporating previous work on the default experience of low-rated corporate debt, this paper presents an introduction to risk-neutral models of risky-bond pricing and uses these to examine the relationship between the default premium embodied in bond yields and actual default rates. The contribution of macroeconomic information to the default premium is also examined. The author finds that holders of low-grade bonds have, on average, been compensated for losses due to default. THE EMERGENCE OF ORGANIZED markets for low-rated corporate (or junk) bonds has provided financial researchers with an opportunity to address a fundamental question: Are holders of default-prone debt compensated (actuarially) for the risk of default? Past research on this market has focused on the default experience of corporate debt. A quite different area of research involves modeling the spreads between the returns of bonds of different credit quality. Few (if any) research efforts have combined these approaches by using actual default experience to explain differential rates of return on low-rated bonds. In this study, a risk-neutral model of the expected probability of default for low-grade bonds is developed as a function of the additional required rate of return on these instruments over default-free bonds. A pricing relationship is derived for the yields to maturity of risky bonds as well as their holding period returns. The default rates implied on corporate bond yields are then compared with a series based on recent corporate bond default experience. Measured holding-period returns, however, are shown to be poor indicators of expected default rates. Next, a "naive" model of expected default rates is suggested as an alternative to the risk-neutral model and subjected to similar tests. Finally, the response of the default premium to changes in the economy is examined. Deviations from expected values of a group of macroeconomic measures will proxy for these changes.

/pdf/the-default-premium-and-corporate-bond-experience-c6o2teaccq.pdf

The Default Premium and Corporate Bond Experience

There is broad consensus that three types of risk confront the potential bond purchaser: the risk of default (possible interest and/or principal loss), the risk of interest rate changes (possible principal loss or gain if the bonds are sold before maturity), and price level risk (loss of purchasing power). The analysis in this paper is directed toward the first of these risks, the risk of default. By assuming that investors require interest rate adjustments on debt subject to default sufficient to give them an expected present value equal to the present value associated with the investment of their funds in default-free securities, we examine the process that determines the risk-adjusted equilibrium interest rate and the factors affecting that rate. We also examine the implications of the model for the cost of debt and a firm's debt capacity.

An Analytical Model of Bond Risk Differentials

IT HAS LONG BEEN AGREED that a business firm faces difficulties in making capital budgeting decisions under uncertainty. Methods that employ either riskadjusted discount rates or dollar risk premiums suffer from a lack of normative theory. There has been no theoretically acceptable method proposed for a businessman to apply in determining the amount by which the time value of money should be adjusted for risk or the size of the dollar risk premium that should be deducted from the net present value of an investment that has been computed using a default free discount rate as the time value of money. For some time the capital budgeting literature has recognized that the risk of an individual investment liesnot only in the degree of uncertainty of that investment's cash flows but also in the extent to which these flows vary with the cash flows from the other assets held by the firm. However, up to very recently, we have not known how to incorporate effectively such risk considerations into the capital budgeting decisions of a firm. This paper attempts to provide a normative theory of capital budgeting under uncertainty based on the valuation of corporate securities in a market where investors hold portfolios of financial assets. It builds on recent articles by Fama [1], Hamada [2], Litzenberger and Budd [5] and Stapleton [12] which, in turn, are based on portfolio and market equilibrium theories developed by Markowitz [6], Sharpe [11], Mossin [7, 8], Lintner [3], Robichek and Myers [10] and Tobin [13]. A careful reading of the cited literature and this paper will reveal our great indebtedness to those authors. We attempt to show that a new investment is acceptable (it will improve the stockholders' wealth position) if the expected present value of the investment is greater than a required present value. The required present value reflects the market's risk-return trade-off and the extent to which the basic uncertainty of the investment's cash flows can be "diversified" away. This result is particularly interesting since it indicates that the decision whether to undertake an investment is independent from the standpoint of risk of the firm considering the investment proposal. Litzenberger and Budd [5] and Hamada [2] have attempted to formulate rules for capital budgeting under conditions of uncertainty using a required rate of return and the basic Sharpe [11] model. They develop a risk-adjusted required return, but this rate is a combination of a time value factor and a risk adjustment. It cannot be used easily to compute the present value of an investment or to evaluate alternatives since the "hurdle rate" in no sense represents the time value of money, that is, a time discount factor. Stapleton [12] does formulate the capital budgeting decision in present

Capital budgeting under uncertainty: a reformulation

Investing in securities : an efficient markets approach

 General Areas of Finance o Financial Markets and Institutions—the financial marketplace and the relationships of banking, insurance, estate planning, and so forth. o Investments—evaluating financial assets, such as stocks and bonds, and determining which investments to include in a portfolio of financial assets. o Financial Services—service organizations and mechanisms related to the management of money. o Managerial Finance—often called corporate finance, includes decisions regarding types of real investments (i.e., plant and equipment) that should be made and how such investments should be financed (i.e., stocks or bonds), whether dividends should be paid, and so forth.

Jerome E. Hass

Papers

An Analytical Model of Bond Risk Differentials

Capital budgeting under uncertainty: a reformulation

Investing in securities : an efficient markets approach

An introduction to managerial finance

Normative stock price models