Financial Taxonomy
Running head: FINANCIAL TAXONOMY
Financial Taxonomy
Ed Jennings
University of Phoenix
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Financial Taxonomy
Financial Taxonomy
Table 1
Financial Theory Taxonomy
Financial
Theory
Primary
Author/Source
Time
Frame
Description of Theory
Capital Structure
Modigliani & Miller
1950-1960’s
There is no material effect on
stock price, regardless of whether
the operation is funded with debt
or equity. The applicability is not
taking into account the funding of
an equity when evaluating the
stock price (Chew, 2001).
Dividend Policy
Modigliani & Miller
1950-1960’s
There is no material effect on the
market value of the stock price,
regardless of whether a dividend is
paid or not. When evaluating a
stock price, the dividend is
accounted for in the price (Chew,
2001).
Agency Cost
Jensen & Meckling
1976
Ownership and control of the
company cannot diverge too far in
their interests or there will be a
potential loss in value of the
company. When evaluating a
company, it is important to access
the goals of the management with
the goals of the stockholders
(Chew, 2001).
Jensen & Meckling
1994
The rational part of human
behavior attempts to draw all of
the interested parties together and
focus on common interests. This
serves as the model for
organizational, financial and
governance of the corporation.
This is also useful in evaluating
the goals of management and
comparing the goals of the
stockholder. The closer the goal,
Resourceful,
Evaluative,
Maximizing,
Model
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Financial Taxonomy
the less likely for a potential loss
in value due to disparate goals
(Chew, 2001).
The Theory of
Stock Market
Efficiency:
Accomplishments
and Limitations
Ball & Brown
1968
Ball and Brown conducted the first
studies in stock market efficiency
by looking at investor’s reaction to
the release of corporate financial
statement information. The market
has a keen ability to process
information directly and
creatively, in a rationale manner.
However, there are anomalies in
which the market overreacts to
certain market conditions (Chew,
2001).
Capital Asset
Pricing Model
Sharpe & Lintner
1964
A method used to determine an
appropriate level of return on the
investment of an asset, given the
risk of that asset. The formula
takes into account the sensitivity
of risk or beta of the asset.
Additionally, the expected return
of the market and the expected
return of the asset without risk are
also taken into account. An
investor has a risk reward tradeoff
in which a higher risk is expected
to yield a higher return
(MacDonald, 2003).
Options Pricing
Model
Black & Scholes
1973
A model used to determine the fair
price of options. Input includes:
price; length of time; volatility;
and the free rate of return (Baril,
Betancourt, & Briggs, 2005).
Dividend Discount
Model
Gordon
1962
This stock valuation tool shows
the present value of future
dividends that a company expects
to pay. This tool helps to estimate
if a current stock is over or
undervalued (Borgman & Strong,
2006).
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Financial Taxonomy
Diamond Model
Porter
1990
Porter outlines the concepts of
clusters. These clusters or groups
are interconnected firms, suppliers,
and institutions that arise in
particular locations. This is very
prominent in Japan, South Korea,
Hong Kong, Taiwan, and Thailand
among others. The theory outlines
4 advanced factors which occur
within these interlinked
companies. These factors can also
be influenced by the government
(Porter, 1990).
Theory of capital
flight in the context
of portfolio choice
Collier, Hoeffler, and
Pattillo
2001
Investors will hold their assets
between domestic and
international markets based on risk
and rate of return (Collier,
Hoeffler, & Pattillo, 2001).
Coase Theorem
Coase
1960
In the absence of transaction costs,
private parties will bargain to
make the government allocation of
property rights equally efficient.
More recently, the government has
auctioned off radio spectrum. If
one buyer needs more spectrum in
the absence of transaction costs,
private parties can make a deal in
which the value of the radio
spectrum reaches its’ value
(Halteman, 2005).
Random Walk
Theory
Fama
1965
Information is available to all
investors inexpensively. Buyers
and sellers negotiate the best price.
Prices will change in the future as
new information become
available. Therefore, it is
impossible to gain greater than
market returns without taking
greater than market risks (Fama,
1995).
Three-Factor Asset
Pricing Model
Fama & French
1992
A tool which is used for asset
allocation and the performance of
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Financial Taxonomy
portfolio management. In this
theory, market size, value factors
in returns and the subsequent
improvement in the Sharpe CAPM
model, comprise the Three-Factor
Asset Pricing Model (Black,
2006).
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Financial Taxonomy
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References
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Accountancy, 200, 57-64. Retrieved January 8, 2007, from
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Black, A. (2006). Macroeconomic risk and the Fama-French three-factor model. Managerial
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Borgman, R. H., & Strong, R. A. (2006). Growth Rate and Implied Beta: Interaction of Cost of
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Financial Taxonomy
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Chew, D. H. (2001). The New Corporate Finance. New York, New York: Irwin.
Collier, P., Hoeffler, A., & Pattillo, C. (2001). Flight Capital as a Portfolio Choice. The World
Bank Economic Review, 15, 55-81. Retrieved January 8, 2007, from
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Fama, E. F. (1995). Random walks in stock market prices. Financial Analysts Journal, 51, 7581. Retrieved January 8, 2007, from
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Halteman, J. (2005). Externalities and the Coase Theorem: A Diagrammatic Presentation.
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Macdonald, J. F. (2003). A Capital Asset Pricing Model with Variable Asset Supply. Review of
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Porter, M. E. (1990). The Competitive Advantage of Nations. New York, New York: Free Press.