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

Book Description

A through guide covering Modern Portfolio Theory as well as the recent developments surrounding it

Modern portfolio theory (MPT), which originated with Harry Markowitz's seminal paper "Portfolio Selection" in 1952, has stood the test of time and continues to be the intellectual foundation for real-world portfolio management. This book presents a comprehensive picture of MPT in a manner that can be effectively used by financial practitioners and understood by students.

Modern Portfolio Theory provides a summary of the important findings from all of the financial research done since MPT was created and presents all the MPT formulas and models using one consistent set of mathematical symbols. Opening with an informative introduction to the concepts of probability and utility theory, it quickly moves on to discuss Markowitz's seminal work on the topic with a thorough explanation of the underlying mathematics.

  • Analyzes portfolios of all sizes and types, shows how the advanced findings and formulas are derived, and offers a concise and comprehensive review of MPT literature

  • Addresses logical extensions to Markowitz's work, including the Capital Asset Pricing Model, Arbitrage Pricing Theory, portfolio ranking models, and performance attribution

  • Considers stock market developments like decimalization, high frequency trading, and algorithmic trading, and reveals how they align with MPT

  • Companion Website contains Excel spreadsheets that allow you to compute and graph Markowitz efficient frontiers with riskless and risky assets

If you want to gain a complete understanding of modern portfolio theory this is the book you need to read.

Table of Contents

  1. Cover
  2. Series Page
  3. Title Page
  4. Copyright
  5. Dedication
  6. Preface
  7. Chapter 1: Introduction
    1. 1.1 The Portfolio Management Process
    2. 1.2 The Security Analyst's Job
    3. 1.3 Portfolio Analysis
    4. 1.4 Portfolio Selection
    5. 1.5 The Mathematics Is Segregated
    6. 1.6 Topics to Be Discussed
    7. Appendix: Various Rates of Return
    8. Notes
  8. Part One: Probability Foundations
    1. Chapter 2: Assessing Risk
      1. 2.1 Mathematical Expectation
      2. 2.2 What Is Risk?
      3. 2.3 Expected Return
      4. 2.4 Risk of a Security
      5. 2.5 Covariance of Returns
      6. 2.6 Correlation of Returns
      7. 2.7 Using Historical Returns
      8. 2.8 Data Input Requirements
      9. 2.9 Portfolio Weights
      10. 2.10 A Portfolio's Expected Return
      11. 2.11 Portfolio Risk
      12. 2.12 Summary of Notations and Formulas
      13. Notes
    2. Chapter 3: Risk and Diversification
      1. 3.1 Reconsidering Risk
      2. 3.2 Utility Theory
      3. 3.3 Risk-Return Space
      4. 3.4 Diversification
      5. 3.5 Conclusions
      6. Notes
  9. Part Two: Utility Foundations
    1. Chapter 4: Single-Period Utility Analysis
      1. 4.1 Basic Utility Axioms
      2. 4.2 The Utility of Wealth Function
      3. 4.3 Utility of Wealth and Returns
      4. 4.4 Expected Utility of Returns
      5. 4.5 Risk Attitudes
      6. 4.6 Absolute Risk Aversion
      7. 4.7 Relative Risk Aversion
      8. 4.8 Measuring Risk Aversion
      9. 4.9 Portfolio Analysis
      10. 4.10 Indifference Curves
      11. 4.11 Summary and Conclusions
      12. Appendix: Risk Aversion and Indifference Curves
      13. Notes
  10. Part Three: Mean-Variance Portfolio Analysis
    1. Chapter 5: Graphical Portfolio Analysis
      1. 5.1 Delineating Efficient Portfolios
      2. 5.2 Portfolio Analysis Inputs
      3. 5.3 Two-Asset Isomean Lines
      4. 5.5 Three-Asset Portfolio Analysis
      5. 5.6 Legitimate Portfolios
      6. 5.7 “Unusual” Graphical Solutions Don't Exist
      7. 5.8 Representing Constraints Graphically
      8. 5.9 The Interior Decorator Fallacy
      9. 5.10 Summary
      10. Appendix: Quadratic Equations
      11. Notes
    2. Chapter 6: Efficient Portfolios
      1. 6.1 Risk and Return for Two-Asset Portfolios
      2. 6.2 The Opportunity Set
      3. 6.5 Markowitz Diversification
      4. 6.6 Efficient Frontier without the Risk-Free Asset
      5. 6.7 Introducing a Risk-Free Asset
      6. 6.8 Summary and Conclusions
      7. Appendix: Equations for a Relationship Between E(rp) and σp
      8. Notes
    3. Chapter 7: Advanced Mathematical Portfolio Analysis
      1. 7.1 Efficient Portfolios without a Risk-Free Asset
      2. 7.2 Efficient Portfolios with a Risk-Free Asset
      3. 7.3 Identifying the Tangency Portfolio
      4. 7.4 Summary and Conclusions
      5. Appendix: Mathematical Derivation of the Efficient Frontier
      6. Notes
    4. Chapter 8: Index Models and Return-Generating Process
      1. 8.1 Single-Index Models
      2. 8.2 Efficient Frontier and the Single-Index Model
      3. 8.3 Two-Index Models
      4. 8.4 Multi-Index Models
      5. 8.5 Conclusions
      6. Appendix: Index Models
      7. Notes
  11. Part Four: Non-Mean-Variance Portfolios
    1. Chapter 9: Non-Normal Distributions of Returns
      1. 9.1 Stable Paretian Distributions
      2. 9.2 The Student's t-Distribution
      3. 9.3 Mixtures of Normal Distributions
      4. 9.4 Poisson Jump-Diffusion Process
      5. 9.5 Lognormal Distributions
      6. 9.6 Conclusions
      7. Notes
    2. Chapter 10: Non-Mean-Variance Investment Decisions
      1. 10.1 Geometric Mean Return Criterion
      2. 10.2 The Safety-First Criterion
      3. 10.3 Semivariance Analysis
      4. 10.4 Stochastic Dominance Criterion
      5. 10.5 Mean-Variance-Skewness Analysis
      6. 10.6 Summary and Conclusions
      7. Appendix A: Stochastic Dominance
      8. Appendix B: Expected Utility as a Function of Three Moments
      9. Notes
    3. Chapter 11: Risk Management: Value at Risk
      1. 11.1 VaR of a Single Asset
      2. 11.2 Portfolio VaR
      3. 11.3 Decomposition of a Portfolio's VaR
      4. 11.4 Other VaRs
      5. 11.5 Methods of Measuring VaR
      6. 11.6 Estimation of Volatilities
      7. 11.7 The Accuracy of VaR Models
      8. 11.8 Summary and Conclusions
      9. Appendix: The Delta-Gamma Method
      10. Notes
  12. Part Five: Asset Pricing Models
    1. Chapter 12: The Capital Asset Pricing Model
      1. 12.1 Underlying Assumptions
      2. 12.2 The Capital Market Line
      3. 12.3 The Capital Asset Pricing Model
      4. 12.4 Over- and Under-priced Securities
      5. 12.5 The Market Model and the CAPM
      6. 12.6 Summary and Conclusions
      7. Appendix: Derivations of the CAPM
      8. Notes
    2. Chapter 13: Extensions of the Standard CAPM
      1. 13.1 Risk-Free Borrowing or Lending
      2. 13.2 Homogeneous Expectations
      3. 13.3 Perfect Markets
      4. 13.4 Unmarketable Assets
      5. 13.5 Summary and Conclusions
      6. Appendix: Derivations of A Non-Standard CAPM
      7. Notes
    3. Chapter 14: Empirical Tests of the CAPM
      1. 14.1 Time-Series Tests of the CAPM
      2. 14.2 Cross-Sectional Tests of the CAPM
      3. 14.3 Empirical Misspecifications in Cross-Sectional Regression Tests
      4. 14.4 Multivariate Tests
      5. 14.5 Is the CAPM Testable?
      6. 14.6 Summary and Conclusions
      7. Notes
    4. Chapter 15: Continuous-Time Asset Pricing Models
      1. 15.1 Intertemporal CAPM (ICAPM)
      2. 15.2 The Consumption-Based CAPM (CCAPM)
      3. 15.3 Conclusions
      4. Appendix: Lognormality and the Consumption-Based CAPM
      5. Notes
    5. Chapter 16: Arbitrage Pricing Theory
      1. 16.1 Arbitrage Concepts
      2. 16.2 Index Arbitrage
      3. 16.3 The Asset Pricing Equation
      4. 16.4 Asset Pricing on a Security Market Plane
      5. 16.5 Contrasting APT with CAPM
      6. 16.6 Empirical Evidence
      7. 16.7 Comparing the APT and CAPM Empirically
      8. 16.8 Conclusions
      9. Notes
  13. Part Six: Implementing the Theory
    1. Chapter 17: Portfolio Construction and Selection
      1. 17.1 Efficient Markets
      2. 17.2 Using Portfolio Theories to Construct and Select Portfolios
      3. 17.3 Security Analysis
      4. 17.4 Market Timing
      5. 17.5 Diversification
      6. 17.6 Constructing an Active Portfolio
      7. 17.7 Portfolio Revision
      8. 17.8 Summary and Conclusions
      9. Appendix: Proofs for Some Ratios from Active Portfolios
      10. Notes
    2. Chapter 18: Portfolio Performance Evaluation
      1. 18.1 Mutual Fund Returns
      2. 18.2 Portfolio Performance Analysis in the Good Old Days
      3. 18.3 Capital Market Theory Assumptions
      4. 18.4 Single-Parameter Portfolio Performance Measures
      5. 18.5 Market Timing
      6. 18.6 Comparing Single-Parameter Portfolio Performance Measures
      7. 18.7 The Index of Total Portfolio Risk (ITPR) and the Portfolio Beta
      8. 18.8 Measurement Problems
      9. 18.9 Do Winners or Losers Repeat?
      10. 18.10 Summary about Investment Performance Evaluation
      11. Appendix: Sharpe Ratio of an Active Portfolio
      12. Notes
    3. Chapter 19: Performance Attribution
      1. 19.1 Factor Model Analysis
      2. 19.2 Return-Based Style Analysis
      3. 19.3 Return Decomposition-Based Analysis
      4. 19.4 Conclusions
      5. Appendix: Regression Coefficients Estimation with Constraints
      6. Notes
    4. Chapter 20: Stock Market Developments
      1. 20.1 Recent NYSE Consolidations
      2. 20.2 International Securities Exchange (ISE)
      3. 20.3 Nasdaq
      4. 20.4 Downward Pressures on Transactions Costs
      5. 20.5 The Venerable Limit Order
      6. 20.6 Market Microstructure
      7. 20.7 High-Frequency Trading
      8. 20.8 Alternative Trading Systems (ATSs)
      9. 20.9 Algorithmic Trading
      10. 20.10 Symbiotic Stock Market Developments
      11. 20.11 Detrimental Stock Market Developments
      12. 20.12 Summary and Conclusions
      13. Notes
  14. Mathematical Appendixes
    1. Appendix A. Expectation Proofs
    2. Appendix B. Simultaneous Solution of Linear Equations
    3. Appendix C. Linearly Dependent Equations
    4. Appendix D. Matrix and Vector Differentiation
  15. Bibliography
  16. About the Authors
  17. Author Index
  18. Subject Index