Bill Sharpe gives CAPM a makeover

[Nords]

After 42 years, Bill Sharpe thinks he can do better than the capital asset pricing model he helped Markowitz develop.

"His latest book, 'Investors and Markets: Portfolio Choices, Asset Prices and Investment Advice,' may send investors and academics scurrying. Published this month by Princeton University Press, the book eschews mean-variance analysis - the mathematically complex formula that relates rewards to risks of securities or portfolios - in favor of a "state preference" approach that relies on an easy-to-understand simulation. That approach is based on a model closer to that used in financial engineering than in the ivory tower. 'I think of it as "beyond mean-variance,"' Mr. Sharpe said in an interview."

Instead of focusing on risk vs reward he's looking at the fat left end of the bell curve where the bubbles, depressions, hyperinflation, and terrorist attacks reside. He tries to provide a way to estimate an investor's desire for protection and he acknowledges that investors aren't rational.

Unfortunately Markowitz doesn't agree with the new concept and the two may be having a cage match next week... I think I'm just going to watch the reviews and hold off reading the book for another six months or so.

[Edit: The linked article was first posted by FundAlarm's Ted.]

 

[FinanceDude]

Don't do it, Bill...............all my memorization will be for naught..........

 

[magellan_nh]

This is facinating, although probably too early to judge.

I've been in a lonely camp for a while, questioning our blind reliance on mean-variance and optimization and I seem to get flamed or made fun of whenever I do it.

I'm interested in his thesis and what he proposes as the "new optimizer".

The work by Benoit Mandelbrot in "MisBehavior of Markets" was really interesting, right up to when he got to the part about what to do next.

We'll see if Sharpe has the same problem.

Thanks for reference Nords...

Jim

 

[brewer12345]

I've been in a lonely camp for a while, questioning our blind reliance on mean-variance and optimization and I seem to get flamed or made fun of whenever I do it.

I'm not about to get upset by someone deviating from the theory, or mean-variance optimization, or CAPM. It is too easy to point to exceptions all over the place. The problem is that there isn't really anything better as of yet. So while one shouldn't be too rigid on this stuff, I don;t think the world of academic finance has come up with anything beter just yet.

 

[magellan_nh]

The problem is that there isn't really anything better as of yet. So while one shouldn't be too rigid on this stuff, I don;t think the world of academic finance has come up with anything beter just yet.

I agree 100% and that's the dilemma. MPT is the worst theory except for all the others that have been tried from time to time.

Now I have to go find some leaches M* tables so I can give my portfolio that much needed blood-letting rebalancing

Jim

 

[donheff]

The work by Benoit Mandelbrot in "MisBehavior of Markets" was really interesting, right up to when he got to the part about what to do next.

Uh, oh. If he's involved does that mean market performance is fractal? Or is he the fractal and chaotic guy? Stop flapping those butterfly wings or I will have to buy an annuity.

 

[FinanceDude]

Uh, oh. If he's involved does that mean market performance is fractal? Or is he the fractal and chaotic guy? Stop flapping those butterfly wings or I will have to buy an annuity.

 

[unclemick]

Da Norwegian widder says: Dividends! Get the dividends.

Of course when whole markets go ka-poof - then perhaps ?world dividends?

Wonder if Bernstein will check in with Angus Maddison.

heh heh heh heh heh

 

[magellan_nh]

FYI, until Sharpe's book is published, he's offering the first two chapters on his web site at http://www.stanford.edu/~wfsharpe/ for free download.

Jim

 

[Nords]

Uh, oh. If he's involved does that mean market performance is fractal? Or is he the fractal and chaotic guy? Stop flapping those butterfly wings or I will have to buy an annuity.

Yeah, you and the Elliott Wave zealots...