https://www.sfu.ca/~wainwrig/Econ400/jensen-meckling.pdf

Theory of the firm: Managerial behavior, agency costs and ownership structure

https://rady.ucsd.edu/faculty/directory/valkanov/pub/classes/mfe/docs/fama_french_jfe_1993.pdf

Common risk factors in the returns on stocks and bonds

This paper introduces an ARCH model (exponential ARCH) that (1) allows correlation between returns and volatility innovations (an important feature of stock market volatility changes), (2) eliminates the need for inequality constraints on parameters, and (3) allows for a straightforward interpretation of the "persistence" of shocks to volatility. In the above respects, it is an improvement over the widely-used GARCH model. The model is applied to study volatility changes and the risk premium on the CRSP Value-Weighted Market Index from 1962 to 1987. Copyright 1991 by The Econometric Society.

Conditional heteroskedasticity in asset returns: a new approach

http://business.unr.edu/faculty/liuc/files/BADM742/Banz_sizeeffect_1980.pdf

The relationship between return and market value of common stocks

SEQUELS ARE RARELY AS good as the originals, so I approach this review of the market efficiency literature with trepidation. The task is thornier than it was 20 years ago, when work on efficiency was rather new. The literature is now so large that a full review is impossible, and is not attempted here. Instead, I discuss the work that I find most interesting, and I offer my views on what we have learned from the research on market efficiency.

https://onlinelibrary.wiley.com/doi/pdf/10.1111/j.1540-6261.1991.tb04636.x

Efficient Capital Markets: II

IN COMPLETE and perfect capital markets, Hirshleifer [6, 7], Robichek and Myers [13], and Stiglitz [15] have shown that the firm's market value is independent of its capital structure. Although firms may issue conventional types of complex securities, such as common stocks and bonds, if the number of distinct complex securities equals the number of states of nature, individuals are able to create primitive securities. A primitive security represents a dollar claim contingent on the occurrence of a specific state of nature and can be created by purchasing and selling short given amounts of complex securities. Since in a perfect market the firm is a price taker, the market prices of these primitive securities are unaffected by the firm's financing mix. Therefore, given the firm's capital budgeting decisions which determine the firm's returns in each state, the firm's market value is independent of its capital structure. The market value of the firm equals the summation over states of the product of the dollar return contingent on a state and the market price of the primitive security representing a dollar claim contingent on the occurrence of that state. The proof of the Modigliani-Miller [8] independence thesis in a statepreference framework does not depend upon the assumption that the firm will earn its debt obligation with certainty. The firm may not earn the "promised" return on its bonds in some states of the world and would be bankrupt. In these states the firm's bonds are claims on the residual value of the firm. Although the firm's financing mix determines the states in which the firm is insolvent, the value of the firm is not affected since bankruptcy penalties would not exist in a perfect market. Therefore, sufficient conditions for the Modigliani-Miller independence thesis are complete and perfect capital markets. The taxation of corporate profits and the existence of bankruptcy penalties are market imperfections that are central to a positive theory of the effect of capital structure on valuation. A tax advantage to debt financing arises since interest charges are tax deductible. Assuming that the firm earns its debt obligation, financial leverage decreases the firm's corporate income tax liability and increases its after-tax operating earnings. However, a corporate bond is not merely a bundle of contingent claims but is a legal obligation to pay a fixed

A state-preference model of optimal financial leverage

contributions to portfolio analysis have been based on the two parameter (meanvariance) model of portfolio selection. Markowitz's normative theory provides the basis for the positive theory of the valuation of risk assets developed by Sharpe [38] and Lintner [27]. The two parameter capital asset pricing model has been subject to numerous applications including performance measurement, tests of security market efficiency and corporation finance.' Recently, Friend and Blume [15], Black, Jensen and Scholes [5], Miller and Scholes [31], Fama and MacBeth [14], and Blume and Friend [8] have published empirical results which are inconsistent with the traditional form of the SharpeLintner model. These studies suggest that the slope of the capital asset pricing model is lower and the intercept higher than predicted by the traditional theory. Using the Cass-Stiglitz [10] observation that the entire mean variance frontier may be generated by linear combinations of any frontier portfolios, Vasicek [41] and Black [6] show that these empirical results are consistent with capital market equilibrium in the absence of borrowing. Unfortunately, the Vasicek-Black modification results in a weaker positive theory since neither the magnitude of the slope nor the magnitude of the intercept of their capital market model is predicted. Brennan [9] shows that under divergent borrowing and lending rates the modified capital asset pricing model predicts that the intercept is bounded by the borrowing and lending rates and, equivalently, that the slope is bounded by the difference between the market's expected rate of return and the lending rate, and the difference between the market's expected rate of return and the borrowing rate. Although Friend and Blume interpret their empirical results as consistent with a mean variance model under divergent borrowing and lending rates, the Black, Jensen and Scholes' empirical results appear to be inconsistent with the predictions of the Brennan modification since the intercept exceeds the borrowing rate. The present paper extends the capital asset pricing model to incorporate the

Skewness preference and the valuation of risk assets

This paper implements the time-state preference model in a multi-period economy, deriving the prices of primitive securities from the prices of call options on aggregate consumption. These prices permit an equilibrium valuation of assets with uncertain payoffs at many future dates. Furthermore, for any given portfolio, the price of a $1.00 claim received at a future date, if the portfolio's value is between two given levels at that time, is derived explicitly from a second partial derivative of its call-option pricing function. An intertemporal capital asset pricing model is derived for payoffs that are jointly lognormally distributed with aggregate consumption. It is shown that using the Black-Scholes equation for options on aggregate consumption implies that individuals' preferences aggregate to isoelastic utility.

Prices of State-Contingent Claims Implicit in Option Prices

The time-state preference approach to general equilibrium in an economy as developed by Arrow (1964) and Debreu (1959) is one of the most general frameworks available for the theory of finance under uncertainty. Given the prices of primitive securities (a security that pays $1.00 contingent upon a given state of the world at a given date, and zero otherwise, is a primitive This paper implements the time-state preference model in a multiperiod economy, deriving the prices of primitive securities from the prices of call options on aggregate consumption. These prices permit an equilibrium valuation of assets with uncertain payoffs at many future dates. Furthermore, for any given portfolio, the price of a $1.00 claim received at a future date, if the portfolio's value is between two given levels at that time, is derived explicitly from a second partial derivative of its calloption pricing function. An intertemporal capital asset pricing model is derived for payoffs that are jointly lognormally distributed with aggregate consumption. It is shown that using the Black-Scholes equation for options on aggregate consumption implies that individuals' preferences aggregate to isoelastic utility.

Robert H. Litzenberger

Papers

A state-preference model of optimal financial leverage

Skewness preference and the valuation of risk assets

Prices of State-Contingent Claims Implicit in Option Prices

Prices of state-contingent claims implicit in option prices

The effect of personal taxes and dividends on capital asset prices