Abstract: An adequate theory of the long-term interest rate should relate the relative yields on four types of assets: money, bonds, goods, and the equity claims to the capital stock. A dynamic model, capable of empirical implementation, must also include expected future changes in the relative prices of these four assets. This paper develops such a theory of the interest rate based on multimarket expectations and shows that it is consistent with the experience of interest rates during the past two decades. In The General Theory [17] Keynes stressed the interdependence between the rate of interest and the state of expectations in the stock market. Subsequent empirical developments of the Keynesian model have, however, ignored the role of equities and focused on only two assets: bonds and money.l A particularly important aspect of our study is to reassert the joint dependence of equity and debt yields and to show the importance of expected capital gains on current bond yields. A second major purpose of this paper is to present alternatives to the traditional empirical model of expected price changes. The fixed weight autoregressive distributed lag is generalized to (1) a variable weight model, (2) a variable influence model with fixed relative weights, and (3) a model with multiple exogenous variables. Alternative methods of estimating variable weight and variable influence

Abstract: A mean-variance equilibrium model is tested against data from the Italian bond market. General equilibrium models under uncertainty were first constructed by Allais [1] and Arrow [2]. The model tested is of the class formulated by Borch [3], on the basis of works by Markowitz [8] and Tobin [18], and developed further by Sharpe [17], Lintner [6] and Mossin [10]. The bonds used in the test are annuity bonds. These are bearer bonds in loans, where the loan is repaid by a constant amount per period in cover of repayment of capital and interest on the loan. A lottery is arranged before each payment date, in order to determine which bonds shall be redeemed by the forthcoming repayment of capital. The bonds not drawn for redemption then participate in the next lottery, which is held one period later. A sequence of such lotteries is arranged, until all bonds in the loan have been redeemed, and the full amount of capital in the loan has been repaid. An annuity bond thus has an uncertain maturity. Its probability of redemption on a future date is given by the repayment plan for the capital of the loan. The certainty alternative which is considered relevant to the investors is investment in Government bonds. With the market for Government bonds assumed to be in equilibrium, this property is used to take account of the time dimension of investment in the annuity bonds. The investors are then assumed to behave in accordance with the von Neumann and Morgenstern theory [11], and establish preferences over probability distributions of present wealth. Such a behavioural assumption was tested earlier in an experiment [15], and gives a reasonable description of investor behaviour. Italian data were chosen, because investors paid no taxes on income from capital gains and interest payments during the period studied.

Abstract: This paper presents simulations of the impact over a three -year period of the introduction of taxable municipal bonds. The primary purpose is to examine the impact of different subsidy rates (33%, 40 % and 50%) on the effects of the taxable bond option. It is found that a 50% subsidy rate is the most suitable on the criteria of equity of the income distribution and the volume of interest saving enjoyed by state -l o cal governments, while on the criteria of least cost to the US. Treasury and efficiency of the transfer a 33% rate is best. Thus, the conventional grounds for such a reform - equity and the benefits to state-local governments - suggest that d 50% subsidy rate should be chosen.

Abstract: One of the most important innovations in bond financing and in mortgage lending has been the rapid adoption of variable-rate instruments in recent years. Notes and bonds bearing an interest rate between one and two percentage points above the prime rate are becoming common in corporate financing. Similarly, variable-rate mortgages (VRM's) with the interest rate tied to the deposit rate of S&L's or linked to the changing yields on competing investments have spread beyond Florida and California to many states. The Federal Home Loan Bank Board has recently endorsed the variable-rate concept and the Federal Home Loan Mortgage Corporation is preparing guidelines for secondary market operations in VRM's. Portfolio managers are thus taking note of the possibility of acquiring long-term instruments providing some of the resiliency of yields and a measure of real value protection characteristic of short-term issues.

Abstract: Despite apparent implications of normative portfolio theory for portfolios that incorporate a wide variety of marketable security forms, most of the literature concerned with application or empirical testing of the theory has considered portfolios composed only of common stocks, cash, and the proverbial riskless bond However, nonequity securities constitute a significant component of investors' total financial wealth, and broadly diversified securities portfolios are commonplace The objectives of this paper are to examine the risk characteristics of 19 classes of long-term marketable securities, ranging from US government bonds to speculative common stocks, and to explore some implications of these characteristics for diversification of actual securities portfolios The first section presents some risk measures for these security classes which are derived from ex post holding period return data for the 18 years, 1951–1968 This section includes an appraisal of the efficacy of alternative approaches to the generation of the matrix of interrelationships among the returns of broad types of securities The second section utilizes the ex post risk measures to explore the composition of minimum risk portfolios consisting of two types of marketable securities, and the final section considers the question of appropriate media for the efficient diversification of common stock portfolios

Abstract: IN A RECENT ARTICLE [7] Jene Kwon and Richard Thornton (K-T) test the hypothesis that FHLB advances to Savings and Loan Associations (S&Ls) are an "efficient method of intermediation," by which they mean that additional debt issued by the FHLB to finance advances is not acquired by actual or potential depositors at S&Ls. Their test of the hypothesis is based on a model of the demand for S&Ls deposits in which the desired stock of S&L deposits is a function of current income and the differentials between the rate offered on S&L deposits and the yields on alternative financial assets. The alternative assets used were FHLB securities, 3-month Treasury bills and AAA corporate bonds. Substituting this description of the desired stock of S&L deposits into a conventional stock adjustment model, and taking first differences, K-T estimated regressions in which the volume of net new savings in S&L deposits is a linear function of the change in income, the changes in yield differentials and the lagged volume of new new savings. They found that FHLB bond yield and Treasury bill yield coefficients had the expected negative signs but that only the FHLB bond yield coefficient was statistically significant when the Treasury bill yield as also included in the regression. On the basis of these results K-T concluded that FHLB bonds are substitutes for savings deposits, and that FHLB advances financed by debt issue are not efficient. They also argued that their results suggest a need for a "reexamination of the current techniques of FHLB open market operations in an attempt to find improved methods of raising funds in the open market, methods to minimize the competitive effect of FHLB bond sales on thrift institution deposits."' This paper has elicited comments from Van Horne [10] and Grebler [4]. Van Horne's comment is directed primarily at econometric problems, among them the problems associated with lagged dependent variables, the possibility of simultaneous equations bias, and the use of first differences. Upon re-estimating the K-T equations using levels rather than first differences Van Horne found that the yield differential between Treasury bills and S&L deposits was statistically significant while the differential with FHLB bonds was not.2 Grebler took issue with the K-T

Abstract: IN THE JUNE 1971 ISSUE, Kwon and Thornton attempt to demonstrate that Federal Home Loan Bank obligations "sold in the open market" compete with savings and loan associations for the same funds and "thus partially deprive them of their deposits," which they consider to be contradictory to the original purpose of the FHLB System.' Their findings, relating to the 1965-1969 period, rest mainly on a regression analysis of a stock adjustment model for selected financial assets using quarterly data. The model explains net new savings at FSLIC-insured S & L associations principally as a function of yield differentials between S & L deposits and other financial assets. Among the latter, FHLB securities emerge as stronger competitors for S & L deposits than do either Treasury Bills or AAA Corporate bonds. That savings flows at S & L associations as well as other deposit institutions were adversely affected by the competition of high-yield credit market instruments during some periods of the 5 years investigated, notably 1966 and 1969, is not a matter of dispute. But the specific results obtained by Kwon and Thornton, which indicate an especially close nexus between S & L deposits and FHLB obligations, warrant close re-examination. First, it should be made clear that the regression analysis merely infers yieldinduced shifts of funds from savings deposits to selected debt securities. It does not show the destination or the magnitude of funds diverted from the savings deposit market. Indeed, the authors make no such claim. It would have been helpful, however, if their cautionary statements on technical aspects of the analysis, such as simultaneous equation bias and intercorrelation of interest rates, had been matched with cautionary statements on substantive interpretation. Second, the analysis is marred by faulty specification of net new savings at S & L associations as the dependent variable. There is no reason in theory or empirical observation to assume that the behavior of S & L depositors varies significantly from that of household savers2 in mutual savings banks or commercial banks when they face alternative investment opportunities at yields substantially exceeding deposit rates. In all three types of institutions, the bulk of funds comes from relatively large accounts whose holders are presumably sensitive to the rate of return, as the authors show in their Table 1 for S & L depositors. Hence, to the extent that FHLB security issues were in competition with savings deposits, the appropriate dependent variable

Abstract: A model of the general obligation municipal bond market provides for an analysis of the credit rating process and for a test of the assumption that credit ratings affect municipal borrowing costs. ...

Abstract: BOTH IN THE THEORETICAL and applied literature of finance the difference in yield-to-maturity between corporate bonds and government bonds has been used as a measure of the incremental riskiness of the former over the latter' While this approach has sometimes provided interesting results, the usefulness of yield spreads is lessened by inherent biases and implicit assumptions as to the pattern of risk adjustment for future promised cash flows This article presents an alternative measure of the incremental risk compensation process over time on risky bonds The proposed alternative views the risky bond price as the discounted present value of future certainty equivalent payments The certainty coefficient, which is the ratio of certainty equivalent to promised payment, gives an implicit measure of risk adjustment for a given future payment period Time series movements in the overall vector of these coefficients (empirically derived at each point in time for a number of future promised payment periods) within a given risk class represent a dynamic picture of changing risk compensation The general methodology of this paper centers upon the estimation of single equation regression coefficients for the certainty coefficient variables and for additional variables representing marketability, callability and tax characteristics for bonds in a given risk class Agency ratings are used to approximate equivalent risk classes and the Almon regression-interpolation procedure is used to estimate structures of certainty coefficients annually from 1952 to 1964 The empirical results over this period for investment grade bonds confirm the usefulness of the approach The study furthermore indicates that, while call options and taxes have the expected effect on bond prices, marketability, as defined, has little impact This outcome has important implications for the use of marketability measures and risk classes and for the apparent efficiency of the bond market