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Working Paper
On the inverse of the covariance matrix in portfolio analysis
The goal of this study is the derivation and application of a direct characterization of the inverse of the covariance matrix central to portfolio analysis. As argued below, such a specification, in terms of a few primitive constructs, provides new and illuminating expressions for such key concepts as the optimal holdings of a given risky asset and the slope of the risk-return efficiency locus faced by the individual investor. The building blocks of the inverse turn out to be the regression coefficients and residual variance optained by regressing the asset's excess return on the set of ...
Working Paper
Exchange rates and foreign direct investment: a note
In "Exchange Rates and Direct Investment: An Imperfect Capital Markets Approach," Kenneth Froot and Jeremy Stein [1991] develop a new finance-based theory to answer an old question--the relationship, if any, between the flow of foreign direct investment and the exchange rate. Their theory, based on the possibility that a foreign firm's borrowing opportunities for financing a U.S. acquisition may be a function of its net worth in dollars, implies a negative relationship between a dollar appreciation and direct investment inflows into the United States. Empirically, the authors find ...
Working Paper
Internal funds and the investment function
An extensive and increasingly persuasive body of empirical evidence has linked a firm's fixed investment expenditure to its supply of internally generated funds. The central concerns of this paper are (1) the theoretical justifiability of such empirically-based investment functions, particularly those where internal funds affect only the speed of adjustment, and (2) the dynamic properties of this latter class of investment functions. A class of models is explored featuring intertemporal profit maximization under conditions of increasing costs of external finance (attributable to bankruptcy or ...
Working Paper
On risk, rational expectations, and efficient asset markets
The notion of asset market efficiency -- that market prices "fully reflect" all available information -- requires the operation of mechanisms that rapidly incorporate new information into asset prices. Particularly problematic -- both theoretically and empirically -- has been the case where new information is not widely shared, so-called "strong-form" efficiency. This paper examines the relevance of a mechanism for attaining strong-form efficiency based on knowledgeable investors being willing to take large positions in order to eliminate unexploited profit opportunities. We examine ...