Frank C. Jen

Effects of Measurement Errors on Systematic Risk and Performance Measure of a Portfolio

In this paper, we examine the effects of errors in measurement of the two independent variables, return on market (Rm) and return on risk-free assets (Rf), in the traditional one-factor capital asset pricing model (CAPM). After discussing Sharpe-Lintners CAPM and both Jensen and Famas specifications thereof, we review briefly the recent results of Friend and Blume [6], hereafter FB; Black, Jensen and Scholes [1], hereafter BJS; and Miller and Scholes (11], hereafter MS. In Section II, we first explore possible sources of measurement errors for both Rm and Rf; then we specify these errors mathematically and derive analytically their effects on estimates of systematic risk of a security or portfolio, , and the Jensens measure of performance, . In Section III, we derive an analytical expression for the regression coefficient of estimated bs where we estimate the equation . The result is then examined to find the conditions under which errors in measurement of Rm and Rf can cause b to have a positive or negative value even if the true b is zero. The conditions are then used to examine FBs results and their interpretation. In Section IV, an alternative hypothesis testing procedure for the CAPM is examined. We show that the empirical results so derived are also affected by the measurement errors and the sample variation of the systematic risk. The relative advantage between the two different testing hypothesis procedures is then explored. Finally, we comment on the relevance of the result to the popular zero-beta model and indicate areas for further research.

Causes and Consequences of the Korean Financial Crisis

During the past decade, the profitability of Korean firms has declined significantly while their business risk has risen substantially. The deteriorating condition was largely due to excessive investments in manufacturing capacity that were financed mainly with short-term debt capital. The measures to restructure the system are summarized in two major thrusts: one, to reform corporate governance so that the business sector becomes more transparent and more value-enhancing; and two, to help develop long-term capital markets so that the domestic financial system becomes less vulnerable to external shocks.

The Deferred Call Provision and Corporate Bond Yields

The purpose of this paper is to estimate empirically the effect of the deferred call provisions on corporate bond yields using the conceptual framework of callable and call-free yields developed by Jen and Wert [3]. After reviewing briefly the above-mentioned study in Section I, Section II presents patterns of callable and call-free yields of deferred issues from January 1956 to June 1961 by grades, months of offering, and coupon rates and contrasts them with those of the freely callable issues. Section III further contrasts yields of deferred issues with those of freely-callable ones on a pair comparison basis, while Section IV discusses the implication of the study for both the issuers and the investors.

A Model of Information Diffusion, Stock Market Behavior, and Equilibrium Price

The determinants of prices of common stocks have been studied extensively by both academicians and practitioners. Differences in points of view between these two groups are evident in their corresponding interpretations of market behavior, which is represented by the assumedly contradictory random walk and intrinsic value “hypotheses.”

The Determination of the Seniority Structure of Debt: Theory and Evidence

The purposes of this paper are to provide a theory of determining the firms optimal seniority structure of debt and examine the relation between the firms seniority structure of debt and its characteristics. Unlike previous studies, we develop a theoretical model which explicitly includes the benefits and costs associated with senior debt financing, corporate taxes, risk-aversion in the capital market, and costs of financial distress. We next show how a value-maximized firm searches for the optimal trade-off among the present values of the tax advantage of debt, loss of tax credits, expected costs of financial distress, costs of senior debt financing, and benefit of limited liability. Numerical analysis results show that the firms value is not only a strictly concave function of its capital structure (with a unique global maximum), but also a strictly concave function of its mix of senior and junior debts (with a unique global maximum). We then show that a firms optimal seniority structure of debt (i.e. the market value of senior debt divided by the sum of the market values of senior and junior debts) increases for low levels of asset riskiness and decreases when asset riskiness becomes sufficiently great. Our model also suggests that a firms optimal seniority structure of debt increases for low levels of growth opportunities and decreases for high levels of growth opportunities. We test the predictions of our model on the relation between the firms seniority structure of debt and its characteristics by using the data for the firms in COMPUSTAT over the 1972 through 1991 time period. The empirical evidence is consistent with our theoretical predictions.

Consumption, Investment, Market Price of Risk, and the Risk-Free Rate

In this paper, we present a new version of the capital asset pricing model CAPM) that provides a linear pricing equation substantially different from that implied by the traditional CAPM of Sharpe [18], Lintner [12], and Mossin [14, 15] (hereafter SLM model). It is assumed that each of the investors has an initial endowment of real resources (say, corn) which can be either consumed invested in investment opportunities available to the investor. A set of simultaneous equations is derived from the model. The set of equations determines the equilibrium values of these interdependent endogenous variables: the amount to be consumed by the investor; the proportion of each investment project be owned by the investor; the amount to be invested in each of the available investment projects; the market value of each project; the market price of risk; and the return imputed by the capital market for a risky project which has a zero-beta risk. If a riskless project exists, the zero-beta rate is just a risk-free rate.