UBC Theses and Dissertations
Essays in capital market equilibrium Harris, Richard Glen
The thesis consists of three essays dealing with related problems of capital market equilibrium under conditions of uncertainty. The method of analysis is the construction and use of two period general equilibrium models. The first essay develops a set of necessary and sufficient conditions, for the determination of equilibrium prices in the well-known Capital Asset Pricing model. A number of structural properties of the equilibrium are determined and applied in investigation of the comparative statics of the model. In particular, the effect on equilibrium prices of changes in the stochastic parameters and number of investors is established. The second essay deals with problems of financing and investment which occur when production and firms are added to the model. It is demonstrated that a "financial inconsistency" may arise as firms pursuing a particular objective, may attempt to invest more than the households in the economy are willing to finance. This possibility has implications for the existence of general equilibrium, admissable decision rules for firms, and the firm's problem of choosing a feasible financial policy. In order to deal with these issues a number of properties of the 'stock market economy' are established. The final essay relaxes the assumption, maintained in the first two essays, that all debt in the economy is default free. A number of simple capital market models are developed which determine an equilibrium interest rate on (risky) debt and an equilibrium probability of default. The comparative statics of these variables are investigated with respect to changes in the riskless rate of interest, the productivity of investment, the expectations of investors, and the transactions costs of default. It is shown that when equity is introduced, then provided bankruptcy is not costless, the market also determines an equilibrium debt/equity ratio.