Axiomatization of residual income and generation of financial securities

Ghiselli Ricci, Roberto and Magni, Carlo Alberto (2009): Axiomatization of residual income and generation of financial securities.

Abstract

This paper presents an axiomatization of residual income, aka excess profit, and illustrates how it may univocally engenders fixed-income or variable-income assets. In the first part it is shown that, depending on the relations between excess profit and the investor's excess wealth, a well-specified theory of residual income is generated: one is the standard theory, which historically traces back to Hamilton (1777) and Marshall (1890) and is a deep-rooted notion in economic theory, finance, and accounting. Another one is the systemic value added or lost-capital paradigm: introduced in Magni (2000, 2003), the theory is enfolded in Keynes's (1936) notion of user cost and is naturally generated by an arbitrage-theory perspective. In the second part, the paper reverts the usual analysis: instead of computing residual incomes profits from a pattern of cash flows, residual incomes are fixed first to derive vectors of cash flows. It is shown that variable- or fixed-income assets may be constructed on the basis of either theory starting from pre-determined growth rates for excess profit. In particular, zero-coupon bonds and coupon bonds traded in a capital market are shown to be deducted as equilibrium vectors of residual-income-based assets.

• Item Type: MPRA Paper
• Language: English
• Keywords: Residual income, excess profit, capital, arbitrage, bond
• Subjects: D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D53 - Financial Markets; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M4 - Accounting and Auditing > M41 - Accounting; G - Financial Economics > G3 - Corporate Finance and Governance > G31 - Capital Budgeting ; Fixed Investment and Inventory Studies ; Capacity; G - Financial Economics > G0 - General > G00 - General; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M2 - Business Economics > M21 - Business Economics; C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling > C60 - General

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