Axiomatization of residual income and generation of financial securities

This paper presents an axiomatization of residual income, also known as excess profit, and illustrates how it may univocally engenders fixed-income or variable-income assets. In the firstpart it is shown that, depending on the relations between excess profit and the investor's excess wealth, a well-specied theory of residual income is generated: one is the standard theory, whichhistorically traces back to Hamilton (1777) and Marshall (1890) and is a deep-rooted notion in economic theory, nance, 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 secondpart, the paper reverts the usual analysis: instead of computing residual incomes prots from a pattern of cash flows, residual incomes are fixed rst to derive vectors of cash flows. It isshown that variable- or fixed-income assets may be constructed on the basis of either theory starting from pre-determined growth rates for excess prot. In particular, zero-coupon bondsand coupon bonds traded in a capital market are shown to be deducted as equilibrium vectors of residual-income-based assets.