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| Jun 1, 2019 | » | 08. A New Walking Shoe: Modern Portfolio Theory
2 min; updated Jan 5, 2025
Many academics agree that to beat the market, one needs to assume greater risk - as opposed to trying to predict the market. This seems simplified. Expected an answer like insider trading, given that it’s hard to beat the market. Defining Risk: The Dispersion of Returns Business Conditions Possibility of Occurrence Expected Return (R) “Normal” economic conditions \(\frac{1}{3}\) 10% Rapid real growth without inflation \(\frac{1}{3}\) 30% Recession with inflation (stagflation) \(\frac{1}{3}\) –10% $$ \mathbb{E}[R] = \frac{1}{3}(.... |
| Jun 1, 2019 | » | 09. Reaping Reward By Increasing Risk
3 min; updated Mar 12, 2022
The mystical perfect risk measure is still beyond our grasp. That said, here are some common ones: Beta and Systematic Risk Systematic risk of a security arises from the variability of the general stock market. Diversification does not reduce this risk. Unsystematic risk is the remaining variability that is due to a company’s particular factors, e.g. a strike. Diversification reduces this risk. There is no reason for extra compensation. Beta is a measure of the systematic risk.... |
| Jun 1, 2019 | » | 10. Behavioral Finance
4 min; updated Mar 12, 2022
Behavioralists believe that: Investors are not rational in present and future valuations of securities. There are substantial barriers to efficient arbitrage. The Irrational Behavior of Individual Investors Overconfidence People tend to be overconfident, e.g. in a survey, 94% of male respondents believed that their athleticism was above average. Hindsight bias makes the world seem predictable. Investors might think they can beat the market. The tendency of “growth” stocks to underperform “value” stocks shows how overoptimistic growth forecasts are.... |
| Jun 1, 2019 | » | 11. New Methods of Portfolio Construction: Smart Beta and Risk Parity
4 min; updated Mar 12, 2022
Smart Beta Using relatively passive-rule based strategies to gain greater than market returns without assuming more risk than investing in a low-cost total stock market index fund. The Sharpe Ratio: (excess return over the risk-free rate) / (risk of the strategy). The risk-free rate is usually the return from a 3-month treasury bill. Higher Sharpe Ratios are better. Smart beta argues that pure indexing (weighting by market cap) is not optimal.... |