Modern Portfolio Theory, + Website Foundations, Analysis, and New Developments

JACK CLARK FRANCIS is Professor of Economics and Finance at Bernard M. Baruch College in New York City. His research focuses on investments, banking, and monetary economics, and he has had dozens of articles published in many refereed academic, business, and government journals. Dr. Francis was an assistant professor of finance at the University of Pennsylvania's Wharton School of Finance for five years and was a Federal Reserve economist for two years. He received his bachelor's and MBA from Indiana University and earned his PhD in finance from the University of Washington in Seattle.

Dongcheol Kim is a Professor of Finance at Korea University in Seoul. He served as president of the Korea Securities Association and editor-in-chief of the Asia-Pacific Journal of Financial Studies. Previously, he was a finance professor at Rutgers University. Kim has published articles in Financial Management, the Accounting Review, Journal of Financial and Quantitative Analysis, Journal of Economic Research, Journal of Finance, and Journal of the Futures Market.

Preface

Chapter 1 Introduction

1.1 The Portfolio Management Process

1.2 The Security Analyst's Job

1.3 Portfolio Analysis

1.4 Portfolio Selection

1.5 Mathematics Segregated to Appendices

1.6 Topics To Be Discussed

Appendix Various Rates of Return

PART One: PROBABILITY FOUNDATIONS

Chapter 2 Assessing Risk

2.1 Mathematical Expectation

2.2 What is Risk?

2.3 Expected Return

2.4 Risk of a Security

2.5 Covariance of Returns     

2.6 Correlation of Returns

2.7 Using Historical Returns

2.8 Data Input Requirements

2.9 Portfolio Weights

2.10 A Portfolio’s Expected Return

2.11 Portfolio Risk

2.12 Summary of Conventions and Formulas

Chapter 3 Risk and Diversification: An Overview

3.1 Reconsidering Risk

3.2 Utility Theory

3.3 Risk-Return Space

3.4 Diversification 

3.5 Conclusions

PART Two: UTILITY FOUNDATIONS

Chapter 4 Single-Period Utility Analysis

4.1 Basic Utility Axioms

4.2 The Utility of Wealth Function

4.3 Utility of Wealth and Returns

4.4 Expected Utility of Returns

4.5 Risk Attitudes

4.6 Absolute Risk Aversion

4.7 Relative Risk Aversion

4.8 Measuring Risk Aversion

4.9 Portfolio Analysis

4.10 Indifference Curves

4.11 Summary and Conclusions

Appendix

PART Three: MEAN-VARIANCE PORTFOLIO ANALYSIS

Chapter 5 Graphical Portfolio Analysis

5.1 Delineating Efficient Portfolios

5.2 Portfolio Analysis Inputs

5.3 Two-Asset Isomean Lines

5.4 Two-Asset Isovariance Ellipses

5.5 Three-Asset Portfolio Analysis

5.6 Legitimate Portfolios

5.7 "Unusual" Graphical Solutions Don’t Exist

5.8 Representing Constraints Graphically

5.9 The "Interior Decorator Fallacy"

5.10 Summary

Appendix

Chapter 6 Mathematical Portfolio Analysis

6.1 Risk and Return for Two-Asset Portfolios

6.2 The Opportunity Set

6.3 Markowitz Diversification

6.4 Efficient Frontier Without the Risk-free Asset

6.5 Introducing A Risk-free Asset

6.6 Summary and Conclusions

Appendix Equations for a Relationship Between  and

Chapter 7 Advanced Portfolio Aanalysis Topics

7.1 Efficient Portfolios Without A Risk-Free Asset

7.2 Efficient Portfolios With A Risk-free Asset

7.3 Identifying the Tangency Portfolio

7.4 Summary and Conclusions

Appendix Mathematical Derivation of the Efficient Frontier

Chapter 8 Index Models and Return Generating Process

8.1 Single-Index Models

8.2 Efficient Frontier and the Single Index Model

8.3 Two-Index Models

8.4 Multi-Index Models

8.5 Concluding Remarks

Appendix

PART Four: NON-MEAN-VARIANCE PORTFOLIOS

Chapter 9 Non-Normal Distributions of Returns

9.1 Stable Paretian Distributions

9.2 The Student-t Distribution

9.3 Mixtures of Normal Distributions

9.4 Poisson Jump-Diffusion Process

9.5 The Log-Normal Distribution

9.6 Conclusions

Chapter 10 Non-Mean-Variance Investment Decisions

10.1 Geometric Mean Return Criterion

10.2 The Safety First Criterion

10.3 Semivariance Analysis

10.4 Stochastic Dominance Criterion

10.5 Mean-Variance-Skewness Criterion

10.6 Summary and Concluding Remarks

Appendix

Chapter 11 Risk Management: Value at Risk

11.1 VaR of a Single Asset

11.2 Portfolio VaR

11.3 Decomposition of A Porfolio’s VaR

11.4 Other VaR’s

11.5 Methods of Measuring VaR

11.6 Estimation of Volatilities

11.7 Accuracy of VaR Models

11.8 Summary and Conclusions

Appendix Delta-Gamma Method

PART Five: ASSET PRICING MODELS

Chapter 12 The Capital Asset Pricing Model (CAPM)

12.1 Underlying Assumptions

12.2 The Capital Market Line

12.3 The Capital Asset Pricing Model

12.4 Over- and Under-Priced Securities

12.5 The Market Model and the CAPM

12.6 Summary and Concluding Remarks

Appendix Derivations of The CAPM

Chapter 13 Extensions of the Standard CAPM

13.1 Risk-Free Borrowing or Lending

13.2 Homogeneous Expectations

13.3 Perfect Markets

13.4 Nonmarketable Assets

13.5 Summary and Conclusions

Appendix

Chapter 14 Empirical Tests of CAPM

14.1 Time-Series Tests of the CAPM

14.2 Cross-Sectional Tests of the CAPM

14.3 Empirical Misspecifications in Cross-Sectional Regression Tests

14.4  Multivariate Tests

14.5 Is the CAPM Testable?

14.6 Summary and Conclusions

Chapter 15 Continuous-Time Asset Pricing Models

15.1 Intertemporal CAPM

15.2 Consumption-based CAPM

15.3 Concluding Remarks

Appendix

Chapter 16 Arbitrage Pricing Theory (APT)

16.1 Arbitrage Concepts

16.2 Index Arbitrage

16.3 The Asset Pricing Equation

16.4  Asset Pricing On A Security Market Plane

16.5 Contrasting APT with CAPM

16.6 Empirical Evidence

16.7 Comparing APT and CAPM

16.8 Concluding Remarks

PART Six IMPLEMENTATIING THE THEORY

Chapter 17 Portfolio Construction and Selection

17.1 Efficient Markets

17.2 Using Portfolio Theories to Construct and Select Portfolios

17.3 Security Analysis

17.4 Market timing

17.5 Diversification

17.6 Constructing an Active Portfolio

17.7 Portfolio Revision

 17.8 Summary and Conclusions

Appendix Proofs for Some Ratios of An Active Portfolio

Chapter 18 Portfolio Performance Evaluation

18.1 Mutual Fund Returns

18.2 Portfolio Performance Analysis During The “Good Old Days”

18.3 Capital Market Theory Assumptions

18.4 Single-Parameter Portfolio Performance Measures

18.5 Market Timing

18.6 Comparing Single-Parameter Portfolio Performance Measures

18.7 The Index of Total Portfolio Risk (ITPR) and the Portfolio Beta

18.8 Measurement Problems

18.9 Do Winners or Losers Repeat?

18.10 Summary About Investment Performance Evaluation

Appendix Sharpe Ratio of An Active Portfolio

Chapter 19 Performance Attribution

19.1 Factor Model Analysis

19.2 Return-Based Style Analysis

19.3 Return Decomposition-Based Analysis

19.4 Concluding Remarks

Appendix Regression Coefficients Estimation with Constraints

Chapter 20 Stock Market Developments

20.1 Recent Stock Exchange Consolidations

20.2 NYSE Diversifies Internationally

20.3 Recent Mergers at Other Stock Exchanges

20.4 Decimalization

20.5 NYSE Trading Orders

20.6 Dealers Make Markets

20.7 High Frequency Trading

20.8 Alternative Trading Systems (ATSs)

20.9 Algorithmic Trading

20.10 Symbiotic Stock Market Developments

20.11 Detrimental Stock Market Developments

20.12 Summary and Conclusions

About the Authors

Index

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