Security Pricing and Investment Criteria in Competitive Markets: Reply

Abstract

Recently, Jan Mossin presented a security pricing model within the framework of a market equilibrium theory. The model is based on particular preference structures of investors, specified in terms of quadratic utility functions with final wealth as the argument of the functions. As an implication of his model for the firm's optimal investment policy, Mossin demonstrates how Proposition III put forth by Franco Modigliani and Merton Miller (1958) can be validated. In addition, the analysis is extended to suggest investment criteria for investments with completely arbitrary yield characteristics. The purpose of this comment is twofold. First, to show that Mossin's proof of the validity of M-M's Proposition III is questionable, given his assumptions. Second, an attempt is made to show how a troublesome assumption of Mossin's analysis could possibly be eliminated. For the sake of exposition, Mossin's securitv pricing model as shown on page 752, equation (6), is stated below with all relevant definitions:

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