Modern Financial Systems: Theory and Applications

PART Five

Applications: Pooled Investments

 

 

 

 

This part covers portfolio governance. Chapter 14 shows how the Capital Asset Pricing and Arbitrage Pricing Theories explain why marketable securities portfolios are diversified, and how securities are priced relative to those diversified portfolios. When the assumptions of the neoclassical paradigm are satisfied, portfolio management is viewed by these theories as a task of balancing risk against return. While there are both static and dynamic versions of the CAPT and the APT, this chapter examines only the static theories. However, the also chapter deals with dynamic aspects of risk management by discussing the construction of synthetic portfolios and portfolio insurance. As in previous chapters, the theories help to provide additional benchmarks for applications. Chapter 14 examines applications to mutual funds, exchange traded funds, and hedge funds. It also considers the risk measure known as Value at Risk (VaR).

Chapter 15 examines portfolios composed mainly of nonmarketable, relatively illiquid securities. Since such portfolios cannot be managed effectively through market transactions, governance techniques focus on other means of influencing portfolio risk and return, mainly by portfolio restructuring and by trading derivative securities. Most such techniques work well under normal market conditions, when transactions can be described as risky. However, when portfolio values can be affected by Knightian uncertainty, the techniques ...