Merton H. Miller

Liquidity and Market Structure

Market liquidity is modeled as being determined by the demand and supply of immediacy. Exogenous liquidity events coupled with the risk of delayed trade create a demand for immediacy. Market makers supply immediacy by their continuous presence and willingness to bear risk during the time period between the arrival of final buyers and sellers. In the long run the number of market makers adjusts to equate the supply and demand for immediacy. This determines the equilibrium level of liquidity in the market. The lower is the autocorrelation in rates of return, the higher is the equilibrium level of liquidity.

A Model of the Demand for Money by Firms

I. Introduction, 413. — II. A model of cash flows and the costs of cash management for business firms, 416; assumptions underlying the model, 417; optimal values of the policy parameters, 420; some properties of the solution, 423; implications for the demand for money by firms, 425; extension to allow for non-zero drift, 427.— III. The applicability of the model, 429. — Appendix, 433.

Dividends and taxes

Abstract We present sufficient conditions for taxable investors to be indifferent to dividends despite tax differentials in favor of capital gains (Strong Invariance Proposition). The conditions include two ‘seemingly unrelated’ provisions of the Internal Revenue Code: (1) the limitation of interest deductions to investment income received and (2) the tax-free accumulation of wealth at the before-tax interest rate on investments in life insurance. Although we use insurance for simplicity in the proof, many tax-equivalent investment vehicles now exist, notably pension funds. Our analysis suggests that the personal income tax is approaching a consumption tax with further drift likely.

Dividends and Taxes: Some Empirical Evidence

This paper reexamines some recent tests of whether holders of shares with higher dividend yields receive higher risk-adjusted rates of return to compensate for the heavier taxes on dividend payments than on long-term capital gains. Our particular concern is with tests using short-run measures of dividend yield--that is, measures that seek to deduce the differential tax burden on dividends over long-term capital gains from differences in rates of return on shares that do not pay a cash dividend during the return interval. We show that such measures are inappropriate for that purpose. Any yield-related effects associated with such measures must arise from sources other than the long-term tax differential. For the short-run measures considered here, the yield-related effects found in some tests are traced to biases, one of a fairly subtle kind, introduced by dividend announcement effects.

Financial Innovation: The Last Twenty Years and the Next

The word revolution is entirely appropriate for describing the changes in financial institutions and instruments that have occurred in the past twenty years. The major impulses to successful financial innovations have come from regulations and taxes. The outlook for the future is for a slowing down of the rate of financial innovation, but much growth and improvement are still in prospect.

A test of the Hotelling Valuation Principle

Time-series tests of the Hotelling r-percent rule for natural resource prices have not been strongly supportive, but the tests and the data are subject to serious difficulties. We propose here an alternative testing strategy based on another but less widely known implication of the Hotelling model. We test this implication, which we call the Hotelling Valuation Principle, by regressing the market values of the reserves of a sample of U.S. domestic oiland gas-producing companies on their estimated Hotelling values. We find that the estimated Hotelling values account for a significant portion of the observed variations in market values and that the Hotelling measures are better indicators of the market values of petroleum properties than two widely cited publicly available alternative appraisals.

The History of Finance

Here is Professor Millers view of what he sees as the highlights of the forty-year-plus life of finance in its modern form, which he characterizes as an interaction of the business school (micro normative) stream and the economics department (macro normative) stream of research. His history extends from finances “big bang” (read Markowitzs “Portfolio Selection” in 1952) through the Sharpe-Litner-Mossin CAPM, the efficient markets hypothesis, and the Modigliani-Miller capital structure propositions to that options research of Black, Scholes, and Merton. The options revolution means that for the first time the field of finance can be rebuilt, according to Miller, on the basis of “observable” magnitudes. Options research the new center of gravity for finance offers much to both the management science/business school wing and the economics wing of the profession.

Commentary: Volatility, Price Resolution, and the Effectiveness of Price Limits

I must admit to having somewhat mixed feelings about the Ma-Rao-Sears article. As one of the very few academics to believe that coordinated circuit breakers might even be worth discussing, let alone enacting, I was pleased to note the message the three authors drew from their study of what happens in commodity futures markets before and after daily price limits are hit. They conclude that following such limit moves, prices tend to stabilize or reverse; and that volatility also tends to drop off substantially when trading resumes. They thus appear to find, as some of the more enthusiastic supporters of circuit breakers, like the Brady Commission, have argued, that commodity price limits act like the beryllium rods in nuclear reactors. They cool off an overheating market but without permanently damaging market liquidity, since the three authors find also that volume does not drop off substantially once trading resumes.

The social costs of some recent derivatives disasters

Abstract On the principle that minus a minus makes a plus, this paper seeks to measure the potential benefits of more regulation for derivatives by estimating the social costs that might have been avoided had regulation somehow prevented such notorious derivatives disasters as those of Procter and Gamble, Metallgesellschaft, Orange County and Barings.

The Orange County Bankruptcy and Its Aftermath: Some New Evidence

The authors study the composition of the Orange County Investment Pool on December 1, 1994. They find that the pool was neither illiquid nor insolvent and that its financial condition did not mandate bankruptcy. If the pool had not been liquidated but had instead been allowed to follow its hold-to-maturity strategy, Orange County would not only have avoided the losses it realized and reported but also would have generated substantial cash inflows during 1995.