Journal of Financial Economics

5 (1977) 189-200. 0 North-Holland

PubKshing Company

CAPITAL

MARKET EQUILIBRIUM IN A MEAN-LOWER PARTIAL MOMENT FRAMEWORK

Vijay S. BAWA and Eric B. LINDENBERG*

Bell Laboratories, Holmdel, NJ 07733, U.S.A. Received February 1977, revised version received June 1977 In this paper, we develop a Capital Asset Pricing Model (CAPM) using a mean-lower partial moment framework. We explicitly derive formulae for the equilibrium values of risky assets that hold for arbitrary probability distributions. We show that when the probability distributions and portfolio returns are either normal, stable (with the same characteristic exponent between 1 and 2 and the same skewness parameter, not necessarily zero), or Student-t distributions, our CAPM reduces to the traditional mean-scale CAPMs. Consequently, since the traditional equilibrium models are special cases of our model, the mean-lower partial moment framework is guaranteed to do at least as well in explaining market data. As an application of our theory, we derive an acceptance criterion for capital investment projects and note that corporate finance theory results developed, for example, in the well-known meanvariance framework carry over to the mean-lower partial moment framework.

1. Introduction

Portfolio selection is a decision problem involving a choice among elements of a set of known probability distributions of returns. It is well known [see Bawa (1975) for a detailed discussion] that the admissible set of portfolios, for investors with Von Neumann-Morgenstern utility functions that correspond to observed economic behavior, is given by the use of Stochastic Dominance (SD) rules. With no restrictions on the probability distributions of security returns, the determination of the admissible set is computationally infeasible because SD rules are complex and involve infinitely many pairwise comparisons of functionals of the underlying probability distributions. The traditional way of circumventing this problem is to assume that the probability distributions of security and portfolio returns belong to a certain family, e.g., normal or stable distributions. 1 In the case of normal distributions, the SD rule reduces to the well-known Markowitz-Tobin (1959, 1958) meanminimum variance selection rule for all risk-averse investors, while the admissible
*We acknowledge helpful comments by a referee and MC. Jensen on Alternatively, one could further restrict attention to a narrower and able class of utility functions (e.g., quadratic or in general power utility the expected utility leads to analytic solutions for arbitrary probability case of quadratic utility, the well-known mean-variance analysis applies. an earlier draft. frequently unacceptfunctions) for which distributions. In the

190

V.S. Bawa and E.B. Lindenberg, Mean-lower partial moments and asset prices

set for all investors is as given in Bawa (1976a). These SD rules are invariant to estimation risk [see Klein and Bawa (1976) for details]. Similarly, for the other two-parameter families of stable distributions, the admissible set of portfolios is generated by the use of mean-scale parameter rules [see Bawa (1975, 1976a) for details]. However, empirical studies of security prices [e.g., Lintner (1972)] reveal that the probability distribution of returns is more likely to be lognormal than normal. For lognormal distributions, the admissible set of portfolios is, as shown in Bawa and Chakrin (1977), given by the use of the two-parameter mean-logarithmic variance rule. In short, under various distributional assumptions commonly employed, optimal portfolio choice is provided by the use of two parameter selection rules, where portfolio mean may be viewed as the return measure and the scale parameter as the risk measure. An alternative way of reducing the dimensionality of the SD rules to that of two-parameter rules, without making undue distributional restrictions, is to note that for arbitrary probability distributions, the SD rules are mean-lower partial moment functional rules where the mean may be viewed as the return measure and the lower partial moment functional, computed at every point in the domain of the underlying random variable, may be viewed as the risk measure. Thus, a selection rule which employs the mean as the return measure and the lower partial moment evaluated at a single point only as a scalar risk measure is a two-parameter rule which theory suggests may be a reasonable approximation for arbitrary probability distributions. As we show shortly, optimal portfolio choice and market equilibrium can be analyzed in this framework just as easily as in the traditional mean-variance, or more generally meanscale frameworks. More importantly, the usefulness of the two parameter mean-lower partial moment framework is that it includes the mean-variance as well as the mean-scale parameter frameworks as special cases under appropriate distributional assumptions. Perhaps, the most appealing quality of the new framework is that it generates an empirical hypothesis of the equilibrium valuation formula that can be tested using available market data without unduly restrictive distributional assumptions, and which reduces to the traditional models when the data supports the distributional assumptions of those models. Consequently, tests of our model must, from a theoretical viewpoint, do at least as well as those based, for example, on the mean-variance criterion. In section 2, we formulate the individual investors portfolio choice problem, state the known Stochastic Dominance results, formulate the mean-lower partial moment (MLPM) rules and show how thay can be solved using techniques already available in the literature [e.g., Ang (1975), Bawa (1976b), and Hogan and Warren (1972)]. We show that the MLPM rules contain the wellknown mean-scale parameter rules as special cases. We then demonstrate that the mutual fund separation property holds for investors optimal portfolio choices. In section 3, we consider capital market equilibrium and explicitly derive equilibrium valuation formulae for prices of risky assets when the lower

VS. Bawa and E.B. Lindenberg, Mean-lower partial moments and asset prices

191

partial moments are computed at the risk free rate. We show that a linear risk-return relationship exists with the excess expected return on any security (excess above the riskless rate of return) equaling the excess expected return on the market multiplied by the systematic (or non-diversifiable) risk of the security. We show that in the MLPM framework, the colower partial moment of the securitys return with the market return divided by the lower partial moment of the market return is the appropriate measure of systematic risk. We also show that the new Capital Asset Pricing Model (CAPM) contains the traditional CAPMs as special cases under the usual distributional assumptions. In section 4, we derive an acceptance criterion for capital investment projects and note that mean-variance corporate financial theory results carry over to the mean-lower partial moment framework. Some concluding remarks are provided in section 5. 2. Portfolio selection under a MLPM criteria Let X denote the investors portfolio allocation with X = (X1, . .., X,,,), and let F, denote the probability distribution of returns on portfolio 37. We assume that no securitys return can be represented as a linear combination of the returns on other securities. The set of feasible portfolios is

if short sales are not allowed and C = {Xl xi Xi = I> if short sales are permitted. An investors optimal choice is a portfolio, from among the set of feasible portfolios, which maximizes the expected utility of his portfolios return. The classes of utility functions that have been studied as meaningful representations of observed economic behavior are defined below, with ui(x) denoting the ith derivative of the utility function and R = [a, b] denoting the domain of the random variables :
u, = MY> 1UI(Y> > 0, u, = 04) b E RI, b E RI, b E RI. (1)

E u, 1uz(v) < 0, > 0,

u, = GO> E U, Id4

The optimal portfolio choice for an investor, with utility function in one of the above classes of utility functions, is contained in the admissible set of portfolios for the appropriate class of utility functions. The admissible set of portfolios is obtained by the use of well-known Stochastic Dominance rules. If we define the nth order lower partial moment of distribution F, computed at point t, LPM,(r; F), as LPM,(t; F) E
(t--)dZQ), s LI

(2)

192

VS. Buwu and E.B. Lindenberg, Mean-lower partial moments and asset prices

and let /.+ denote the mean of distribution F,2 the SD rules are summarized by the following theorem, proved in Bawa (1976b):
Theorem 1. and only if

(i) F is preferred LPM,_,(t;

to G for all utility functions in Ui, i = 1,2, if

F) 6 LPMI_,(t;

G),

Vt E R

and < for some t;

(ii) F is preferred to G for all utility functions in U, if and only if

and

LPM,(t; F) 6 LPM,(t; G),

Vt E R

and < for some t.

For arbitrary probability distributions, and with an infinite choice set (C or CNs), it is not possible to perform all the pairwise comparisons mandated by Theorem 1 as necessary to identify the admissible set of portfolios. The usual procedure is to restrict the class of distribution functions so that the task is analytically feasible [see Bawa (1975) for detailed discussion]. As an alternative to making distributional assumptions, a subset of the admissible set of portfolios, which provides a lower bound to the full admissible set for arbitrary probability distributions, can be obtained by evaluating the lower partial moment of order n = 1, 2, at a fixed point only [see Bawa (1976b) for discussion]. In this way, we can compare alternative portfolios having the same mean return and choose among them according to the minimum lower partial moment (LPM,) evaluated at the fixed point. For portfolio selection problems, we will take the fixed point as rF, the risk-free rate of return, which may be viewed as the opportunity cost of investing in a risky portfolio and thus has intuitive appeal. 3 Before stating the portfolio selection problem in the MLPM framework, we need some additional notation. Let Ri, i = 1,2, . . ., m, denote the random return on the ith basic security and let F z F(R,, . . . . R,) be the joint distribution of returns. Let Ei denote the mean return on security i. The distribution of returns for portfolio X, F,, is derived from F. Contracting the notation of (2) a bit, LPM,(r,; X) E I denotes the nth order lower partial moment of the distribution of returns under portfolio X, computed at the risk-free rate r,. Portfolio selection under the
ZThe integrals used throughout are Lebesgue-Stieltjes integrals, and they are assumed to be bounded. Also, we assume that the distributions have finite means. We note that by integrating (2) by parts n times, LPM,(r; F) is n factorial times the n fold integral of the distribution function F that is commonly used in stating nth order Stochastic Dominance Rule. 3While the portfolio selection problem can be solved for any fixed point, the separation and equilibrium results discussed later in this paper obtain only when the fixed point is rF.

F (r, -v> dF,(y)

(2)

VS. Bawa and E.B. Lindenberg, Mean-lower partial moments and asset prices

193

MLPM criteria is given by the solution to the following optimization problem, forn = 1,2:

min LPM,(r,;
X (1)

X),

subject to XE C (or

c XiEi = p, XE&~).~

Bawa

(1976b) has shown that LPM,(r,, X) is a convex function of X. Since we are minimizing a convex function over a convex set, standard programming algorithms can be used to solve (I).5 As noted in Bawa (1976b), the optimal value of LPM,(r,; X), as a function of p [denoted as LPM,(p)J, is increasing and convex over all p greater than the mean, &z, TV),of the portfolio that yields the minimum lower partial moment over the feasible set C (or C,,). This is the same property exhibited by the

LOWER PARTIAL MOMENT AT RISKLESS RATE LPM,(rF;XI

LPM,(p)

EXPECTED

RETURN, p

Fig. 1. Admissibleset. admissible boundary in mean-variance space under the distributional approximations of traditional portfolio theory. Thus, the admissible boundary in MLPM framework, represented by curve AB in fig. 1, is the solution to (I) for p 2 !4n, rF)* Suppose that a riskless asset is also available and that X0 is the proportion of initial wealth that the investor places into that asset. Let X = (X1, . . . , X,) 4The sets C and C,, are convex, and our results apply as well to any choice set which is a convex subset of C or CNS. These subsets can account for various institutional restrictions placed upon the feasible set of portfolios for an investor. Se, for example, detailed discussion and references in Bawa (1976b).
F

194

VS. Bawa and E.B. Lindenberg, Mean-lower partial moments and asset prices

now represent the proportions of his risky portfolio held in each risky asset. Then if X = (X0, X), the investors problem (I) reduces to min LPM,(r,; I), % (I) subject to XEC We note that %F - X,r, X,)LPM:/(r,; (or f
f-1

(1 -X,)XiEi+ XE C,,).

Aor, = p,

(1- X&Y dFx(y)

X).

1
l/n

(3)

Eq. (3) implies that in the mean-LPM: space, linear combinations of a portfolio X of risky assets and the riskless asset lie along a straight line. Because of convexity of the LPM,&) function, this implies that the risky portfolio which in combination with the riskless asset yields the minimum lower partial moment for all mean returns is found by drawing a tangent to the admissible boundary (AB in fig. 2) from the point r, .6 Thus, the separation property of the traditional portfolio theory still obtains and M, the point of tangency in fig. 2, may be termed the market portfolio of risky assets. We note that fig. 2 is identical to Sharpes graphical solution to the optimal portfolio choice problem with (LPM,)(n = 1,2) replacing standard deviation as the relevant risk measure. Our mutual fund separation result above, useful in the derivation of market equilibrium pricing relationships in the next section, is summarized by the following:
Theorem

n = 1 and

2. The optimal portfolio choice in a MLPM, framework for the cases 2 admits separation between the riskless asset and the market portfolio

of risky assets.

The appropriateness of the mean-lower partial moment framework used here is perhaps best illustrated by the result that when the distributions of security and portfolio returns are normal, Student-t or stable [with the same
6We assume that there exists a unique tangency point, which in turn, guarantees the existence of a unique market equilibrium. We assume that r, 5 p(n, rp); a unique tangency is then guaranteed if LPMA @) is convex. For n = 1, this is true since LPM1(p) is convex. For n= 2, convexity of LPM&) is not sufficient and in addition requires that ln(LPM&)) be convex. In keeping with the literature, we assume that this holds. In the mean-variance analysis, positive definiteness of the covariance matrix is sufficient to guarantee that not only a(p) (the minimum variance over all feasible portfolios for a fixed mean p) but a(p) be convex [see, for example, Merton (1970)]. We are unable to provide equivalently simple sufficient conditions for general distributions.

V.S. Bawa and E.B. Lindenberg, Mean-lower partial moments and asset prices

195

characteristic exponent CI,between one and two, and the same skewness parameter (not necessarily zero)], the MLPM, portfolio selection rule, so long as LPM, exists7 for n = 1 and 2, reduces to the well-known mean-scale selection rule. This result follows directly from the observation that all of the aforementioned distributions belong to the generalized location and scale family of distributions (Fo,,), defined in Bawa (1975), for which the Stochastic Dominance rules, given by Theorem 1, reduce to mean-scale selection rules. Since the SD

LPMk (FL) RISK MEASURE LPMy(rF;X)

P(VF)
EXPECTED RETURN, p

Fig. 2. Determination

of capital market equilibrium.

rules

require minimization of LPM,(t; X) for every t in the domain of the random variables, they certainly require minimization at t = r,. Thus, the following theorem holds: 8 Theorem

3. The admissible set under the MLPM, framework, obtained as the union of solutions to (I) for all p 2 p(n, rr), is identical to the admissible set under a mean-scale framework if either: (i) n = 1 and the distributions of security andportfolio returns F(.) are normal, Student-t, or stable (with the same characteristic exponent CI, between one and two, and the same skewness parameter, not necessarily zero), or (ii) n = 2 and the distributions of security and portfolio returns F(a) are normal or Student-t.
LPM,(r=; A) exists for all these distributions. LPM2(rF; X) exists for normal and Student-t but not for stable with a < 2. *Theorem 3 also generalizes Theorem 3 in Bawa (1976b). Indeed it shows that the second and third-order Safety-First rules [see Bawa (1976b) for definition] generate the same set of portfolios as the common admissible set of portfolios for classes U, , and U1 of utility functions for the families of distribution functions described above.

196

V.S. Bawa and E.B. Lindenberg, Mean-lower partial moments and asset prices

Thus, the MLPM, portfolio selection rules may be used with the understanding that under appropriate distributional assumptions, they contain the well-known mean-variance and mean-scale portfolio selection rules as special cases. In the next section we use this framework to develop a capital asset pricing model with no restrictions on the distribution functions.

3. Capital market equilibrium Under the assumption that all investors have homogeneous expectations about future returns, i.e., about the distribution of security returns F(a), as well as other standard assumptions used in the literature in the analysis of capital market equilibrium [see, for example, Sharpe (1964), Lintner (1965), Mossin (1966)], results in the previous section indicate that the following graphical and analytical methodology used in Sharpe (1964) can be directly employed to find the market equilibrium pricing relationship: In fig. 2, if M represents the tangency portfolio of AB with the capital market line, then the slope of that line is LPM,!(r,; M)/(E(R,) -rr). For any security j = 1,2, . . . , m (or equivalently any portfolio), represented as point J in fig. 2, portfolios that consist of a fraction a in security j and (1 -a) in the portfolio M lie along the curve JMC in fig. 2 which is continuous and is, in equilibrium, tangent to AB at point M, where a = 0, and thus in turn is tangent to the capital market line. Since we know the slope of the capital market line, the equilibrium pricing relationship is directly obtained by equating it to the slope of the curve JMC at point M. The equilibrium pricing relationship in the MLPM, framework derived using Sharpes methodology, usually called the security market line, can be summarized by the following :
Theorem 4. Under the standard assumptions employed in analysis of capital market equilibrium, if all investors evaluate portfolios in a MLPM, framework, or evaluate portfolios in a MLPM, framework, then the market equilibrium prices satisfy the following relationship, with n = 1 or 2 appropriately, E(Rj)-rp where = flyLpMn(E(R&rr), j = 1,2, . . . , M, (4)

BYLPMnLPM,(r,; =

CLPM,h ; M .i)
M)

(5)

gThe result for n = 2 has also been derived in Hogan and Warren (1974). Our results provide the rationale for using MLPM. framework, and show its intimate relationship to other traditional models.

V.S. Bawa and E.B. Lindenberg, Mean-lowerpartial moments and asset prices

197

and where CLPM,(r,; M, j), the colower partial moment of order n between the returns Rj on security j and R, on the market portfolio M, is given by a,

CLPM,(r,;

M, j) =

F
I rM=-m s r,=-m

(rr - rM)n- (rr - rj) dR(r,, rj>,

(6)

and where LPM,(r,;

M) is defined by (2).

We note that (4), the security market line in the mean-lower partial moment framework, is identical in form to the traditional Capital Asset Pricing Model obtained in the mean-variance (MV) framework except that /IT = COV(R,, RJ/Var(R& is replaced by j3jMLPMn. the mean-lower partial moment framework, the In market portfolio, M, has positive risk (LPM,(r,; M) > 0) only when the return of that portfolio has some positive probability of falling below rF. By the definition of pjMLPMn, particular security contributes to the markets risk only a when its return, as well as the markets return, are below rr. When Rj < r, and R, > r, security j reduces the risk of M. On the other hand, when the markets return exceeds the risk-free rate, by definition individual security returns contribute nothing to the markets risk regardless of whether Rj$ rF. It should be noted that Theorem 4 has been derived for arbitrary probability distributions. As is evident from Theorem 3, the market equilibrium relationship of Theorem 4 contains, as special cases, the well-known CAPM when the distribution belongs to one of the restricted families described in Theorem 3 [see Sharpe (1964) Lintner (1965) and Mossin (1966) for the case of normal distributions and Fama (1971) for symmetric stable distributions]. Consequently, on theoretical grounds, tests of the empirical hypothesis generated by Theorem 4 must do at least as well as tests of any of the traditional CAPMs that correspond to its special cases [see Jensen (1972) and Roll (1977) for discussions of the popular testing procedures]. For illustrative purposes, we now show that eq. (4) reduces to the CAPM in a mean-variance framework. In case of normality, one notes that from the properties of multivariate normal distributions [see, for example, Johnson and Kotz (1972, p. 86)],
E[rF-Rj)R,,, = rM] = rF-E(Rjjw oMM - E(R& (rM (7)

where ajM = COV(Rj, R,) and (Tag = Var(R,). Substituting (7) into the expression for CLPM,(r F; M, j) in (6) we obtain after some simplification, for n = 1,2,

198

VS.Bawa and E.B. Lindenberg, Mean-lower partial moments and asset prices
CLPM,(r,; M,j) = zLPM,(rF;
CMM

M)

/jjMLPM-

CLPM,(r,;

M,j)/CLPM,(r,;

M, M)

Pi 1+ WL) - TF)
-(E(RJ-rF)
LPM,(r,;

LPM,-l(r,; M)
LPM,(rF; M)

1 M) (9)

LPMn-,(r,; M)

where Pi E
cjM/o,UM,

the equilibrium risk measure in the mean-variance framework. We note by substituting from (9) into (4) that the CAPM under the MLPM, framework reduces to E(Rj) Indeed,
rF =

~~~"(_E'(RM)-TF).
in the mean-variance framework.

(10)

(10) is the CAPM

4. Implications for corporate decision-making

We have shown that in equilibrium, the linear risk-return relationship of the traditional mean-variance framework still holds with the risk measure being appropriately changed for security j from fly to /?yLPMn. Since all of the other assumptions are the same, the results contained in Rubinstein (1973) on applying the mean-variance CAPM to modern finance theory carry over in the meanlower partial moment framework as well. In particular, the irrelevance of corporate financial policy to the value of the firm holds in the mean-lower partial moment framework. We now derive the firms investment decision rule in the new framework. We consider a firm evaluating a marginal investment project whose cost is Ij. The firm is a price-taker with respect to the market price of risk [i.e., it views that R, is unaffected by its own decisions; see Rubinstein (1973) for detailed formulation of the problem]. Suppose the firm is an all equity firm which currently has Nj shares each priced at Pj.It must be that in equilibrium, with Xj denoting the total return to firm j, and Rj = Xj/NjPj,"
(The second line of (11) follows directly by noting that from (6), CLPM.(r,; M,j) Pr(R, 6 rP)E[(rF-RI)(rP-RY)I-l = IRM i rp].

VS. Bawa and E.B. Lindenberg, Mean-lower partial moments and asset prices

199

xj
[ NjPj

= rF+ACLPM,(rF;

M,i)

= r,+lPr(R, x(r,-I?,)-II?,

S rF)E[kF-&) < r, ,

(11)

where 1 = (E(&)-r,)/LPM,(r,; M). Suppose after the investment, the firms total return is Xj = Xj+XT, and that the firm finances the investment with NY additional shares. Then, after equilibrium is reached,

x (rF-&yel

I&

<

rF

(12)

where Pj is the new equilibrium price per share and Ais assumed to be unchanged. It follows that the project will increase the firms price per share and thus should be accepted if and only if
E[R;] 2 r, + /?~LPM(E(i?M) -rF),

(13)

where PyMn is the systematic risk of the project. Thus the expected return on a project should exceed its risk-adjusted cost of capital, given by the right-hand side of (13). This criterion is the same as that given in Rubinstein (1973) except that flFLPMn now replaces SE as the appropriate measure of risk. Because the risk measure naturally differs from model to model, projects acceptable in one context may be unacceptable in another. 5. Concluding remarks We have developed in this paper a model of equilibrium in capital markets in which investors choose portfolios on the basis of the mean return and a lower partial moment of each portfolio. This criteria provides a method for computing a subset of the admissible set of portfolios derived from stochastic dominance analysis without making any of the distributional assumptions that are needed to develop the traditional capital asset pricing models. We have shown that the traditional mutual fund separation property holds, and that, in equilibrium, a security market line exists relating expected excess returns on
These results depend crucially on the assumption that the firm is a price-taker with respect to A. Mossin (1973) has formulated this problem in a total returns framework in which price taking is defined somewhat differently and found, for example, that the investment decision depends on which firm is considering it. For an alternative use of the price taking assumption for which (13) also follows, see Jensen and Long (1972).

200

V.S. Bawa and E.B. Lindenberg, Mean-lower partial moments and asset prices

each security to the expected excess return for the market. The measure of systematic risk for each security is the colower partial moment of the securitys return with the market return and can be computed for arbitrary distributions. We showed, however, that our results contain, as special cases, the traditional capital asset pricing models under common assumptions about the distributions of security and portfolio returns. Our market equilibrium model, therefore, generates a testable hypothesis which can handle whatever probability distributions of security returns that are supported by the market data, and is guaranteed to perform at least as well as any of the special cases that it contains. References
Ang, J., 1975, A note on the E,SL portfolio selection model, Journal of Financial and Quantitative Analysis 10, 849-857. Bawa, V.S., 1975, Optimal rules for ordering uncertain prospects, Journal of Financial Economics 2, 95-121. Bawa, VS., 1976a, Admissible portfolios for all individuals, Journal of Finance 41,1169-1183. Bawa, VS., 1976a, Safety first, stochastic dominance and optimal portfolio selection, Bell Laboratories Economic Discussion Pawr no. 60. Journal of Financial and Ouantitative Analysis (forthcoming). Bawa, V.S. and L.M. Chakrin, 1977, Optimal portfolio choice and equilibrium in lognormal securities market, Bell Laboratories Economic Discussion Paner no. 86. Fama, E.F., 1971, Risk, return and equilibrium, Journal of Polit;cal Economy 79,30-55. Hogan, W.W. and J.M. Warren, 1972, Computation of efficient boundary in the E-S portfolio selection model, Journal of Financial and Quantitative Analyses 7, 1881-1896. Hogan, W.W. and J.M. Warren, 1974, Toward the development of an equilibrium capital market model based on semivariance, Journal of Financial and Quantitative Analysis 9, 1-12. Jensen, M.C., 1972, Capital markets: Theory and evidence, Bell Journal of Economics and Management Science, Autumn, 357-398. Jensen, M.C. and J.B. Long, 1972, Corporate investment under uncertainty and Pareto optimality in the capital markets, Bell Journal of Economics and Management Science, Spring, 151-174. Johnson, N.L. and S. Kotz, 1972, Continuous multivariate distributions (Wiley, New York). Klein, R.W. and V.S. Bawa, 1976, The effect of estimation risk on optimal portfolio choice, Journal of Financial Economics 3, 215-231. Lintner, J., 1965, The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets, Review of Economics and Statistics 47, 13-37. Lintner, J., 1972, Equilibrium in a random walk and lognormal securites market, Discussion Paper no. 235, July (Harvard University Institute of Economic Research, Cambridge, MA). Markowitz, H., 1959, Portfolio selection: Efficient diversification of investments (Wiley, New York). Merton, R., 1970, An analytic derivation of the efficient portfolio frontier, Journal of Financial and Quantitative Analysis 25, 1005-1027. Mossin, J., 1966, Equilibrium in a capital asset market, Econometrica 34, 768-783. Mossin, J., 1972, Theory of financial markets (Prentice-Hall, Englewood Cliffs, NJ). Roll, R., 1977, A critique of the asset pricing theorys tests; Part 1: On past and potential testability of the theory, Journal of Financial Economics 4, 129-176. Rubinstein, M., 1973, A mean-variance synthesis of corporate financial theory, Journal of Finance 28, 167-182. Sharpe, W.F., 1964, Capital asset prices: A theory of equilibrium under conditions oi risk, Journal of Finance 19,425-442. Tobin, J., 1958, Liquidity preference as behavior towards risk, Review of Economic Studies 25, 65-86.