EMPIRICAL RESEARCH in the field of corporate finance and investment has been involved in the estimation of the strength of the effect that a set of stimuli variables has upon a set of reaction variables. The former set, the stimuli variables, has been defined variously as earnings, dividends, debt leverage ratios, etc.; the latter set has, to the best of our knowledge, usually been a single security's value or a transformation thereof. It is the purpose of this note to suggest that this second set, the reaction variables, deserves more attention and elaboration so that rather than usually being restricted to a single firm's value, one could, consonant with the real system of equity markets, examine a set of security values that is determined by the market system. This would help to bring empirical research more in line with the contributions made by authors such as Tobin, Sharpe, Lintner, and Lerner and Carleton to the theory that the equity markets are essentially a system where many investors simultaneously seek to maximize their utility by allocating their available liquidity among the various equities.We are aware that a number of researchers in the field have previously grappled with the fact that the market is multivariate rather than univariate and that their selection of a single equation model is the result of thorough deliberation. It is our point that very little has been written to the effect that a multivariate statistical model would probably better describe the market system that determines equity values. We feel that an open discussion of the issue would be of value to those who may not have thought much about a simultaneous market system before, and for those who have, it may help to stimulate discussion and produce some written comment which will help to construct the necessary multivariate models. [9], p. 243). Thus, in both theory and reality, it appears that the reaction variables germane in the investigation of equity valuation or price movements are not a single security value, but the set of security values that is jointly determined by a given market. Therefore, the market system can be described as:. * Indiana University and North Carolina State University respectively. We are in debt to Willard Carleton, Donald Tuttle, Michael Keenan, Avery Cohan, and the reviewer for their suggestions and comments. All errors of commission and omission are solely ours.
The development of portfolio theory in the works of Markowitz [19], Sharpe [24], Tobin [29], Samuelson [23], and Lintner [14], [16], [17], [18] has evolved a normative theory of investment behavior that has predicated that the investor under a broad class of assumptions will rationally diversify his investment in risky assets. Studies have shown that individuals and institutions, voluntarily acting for individual investors, do in fact seek diversification of their portfolio of risky assets (Jensen1. It should be noted that reaction variables may be expressed as a transformation, i.e., logarithmic, first difference, etc. of the security v...
