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Portfolio Theory and Practice Read chapter Read first chapter

2023 | OriginalPaper | Chapter

2. Capital Market Conditions

Authors : James W. Kolari, Seppo Pynnönen

Published in: Investment Valuation and Asset Pricing

Publisher: Springer International Publishing

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Abstract

This chapter covers different aspects of capital markets that are essential to understanding asset pricing. Topics include perfect capital markets, efficient markets, risk aversion, and normally distributed returns.

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Appendix
Available only for authorised users
Footnotes
1
See Shiller (2000), who titled his book “Irrational Exuberance” after a warning by Federal Reserve Chairman Alan Greenspan of a possible market bubble in 1996.
 
2
It is possible that limits to arbitrage can occur due to constraints on traders arising from institutional or structural restrictions in the financial market. For example, an investor that borrowed money to buy an asset could face a margin call to cover losses on the asset that are short run in nature due to a temporary market panic. These sudden losses could prevent arbitrage gains from being realized such that equilibrium prices cannot be achieved.
 
3
As discussed shortly in the context of strong-form efficiency, private or inside information of managers of companies exists, but managers cannot legally trade on this information. Also, securities firms cannot pay firms for inside information that is not publicly available.
 
4
According to Fama and Miller (1972, p. 339, footnote 19), further RWH assumptions are that prices are identically distributed and that expected price changes can be nonzero due to drift.
 
5
See Friedman and Savage for the case in which \(I_0 > \bar{I}(A)\).
 
6
Risk lovers would have a concave downward-shaped indifference curve.
 
7
For a risk lover, we have \(0< b < 1\).
 
8
As shown by Tobin (1958, p. 76), this assumption limits the range of mean returns R.
 
9
See Wikipedia on the internet for an excellent review of the Taylor series. This mathematical method enables the evaluation of a general function with incremental accuracy by a polynomial of finite order. Often even the first-order approximation provides a sufficiently accurate approximation for practical purposes.
 
Literature
Fama, E.F. 1970. Efficient capital markets: A review of theory and empirical work. Journal of Finance 35: 383–417.CrossRef
Fama, E.F., and M.H. Miller. 1972. The Theory of Finance. Hinsdale, IL: Dryden Press.
Friedman, M., and L. Savage. 1948. The utility analyses of choices involving risk. Journal of Political Economy 56: 279–304.CrossRef
Jegadeesh, N., and S. Titman. 1993. Returns to buying winners and selling losers: Implications for stock market efficiency. Journal of Finance 48: 65–91.CrossRef
Lintner, J. 1965. The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets. Review of Economics and Statistics 47: 13–37.CrossRef
Malkiel, B.G. 2003. A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing. New York, NY: W.W. Norton.
Markowitz, H.M. 1952. Portfolio selection. Journal of Finance 7: 77–91.
Markowitz, H.M. 1959. Portfolio Selection: Efficient Diversification of Investments. New York, NY: Wiley.
Mossin, J. 1966. Equilibrium in a capital asset market. Econometrica 34: 768–783.CrossRef
Sharpe, W.F. 1964. Capital asset prices: A theory of market equilibrium under conditions of risk. Journal of Finance 19: 425–442.
Shiller, R.J. 2000. Irrational Exuberance. Princeton, NJ: Princeton University Press.
Tobin, J. 1958. Liquidity preference as a behavior toward risk. Review of Economic Studies 25: 65–86.CrossRef
Treynor, J.L. 1961. Market value, time, and risk. Unpublished manuscript.
Treynor, J.L. 1962. Toward a theory of market value of risky assets. Unpublished manuscript.
von Neumann, J., and O. Morgenstern. 1944. Theory of Games and Economic Behavior. Princeton, NJ: Princeton University Press.
Metadata
Title
Capital Market Conditions
Authors
James W. Kolari
Seppo Pynnönen
Copyright Year
2023
Book
Investment Valuation and Asset Pricing

Print ISBN: 978-3-031-16783-6

Electronic ISBN: 978-3-031-16784-3

Copyright Year: 2023

DOI
https://doi.org/10.1007/978-3-031-16784-3_2