Theory and Portfolios: An Economic History of Mpt, Apt, and the Capm from 1952 to 1986.

THEORY AND PORTFOLIOS

An economic history of MPT, APT, and the CAPM from 1952 to 1986.

NICHOLAS JEWCZYN, PH.D.

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Published by AuthorHouse 01/07/2014

ISBN: 978-1-4918-4656-8 (sc)

ISBN: 978-1-4918-4655-1 (e)

Library of Congress Control Number: 2013923379

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CONTENTS

Disclaimer

Dedication

Preface

Acknowledgements

Abstract

About the Author

THEORY

Introduction

Foundational Financial Economics Theory of Markowitz

Markowitz’s Seven Assumptions

Decisions Regarding Efficient Securities Portfolios

Isolating Efficient Portfolios to Maximize Return and Minimize Risk

A Summary of Markowitz’s Changes to Modern

Portfolio Theory

Jack Treynor as a CAPM Primary Theorist

Synthesis of Treynor’s Portfolio Theory Work

Summary of Treynor’s Version of the CAPM

William Sharpe as a CAPM Primary Theorist

Synthesis of Sharpe’s Modern Portfolio Theory Work

Summary of Sharpe’s Version of the CAPM

John Lintner as a CAPM Primary Theorist

Synthesis of Lintner’s Modern Portfolio Theory Work

Summary of Lintner’s Version of the CAPM

Jan Mossin as a CAPM Primary Theorist

Synthesis of Mossin’s Modern Portfolio Theory Work

Summary of Mossin’s Version of the CAPM

Stephen Ross as an APT Primary Theorist

Synthesis of Ross’ Modern Portfolio Theory Work

Summary of Ross’ APT

Financial Economics Secondary Theorists

Fischer Black, Michael Jensen, and Myron Scholes as Theorists

Douglas Breeden as a Theorist

Robert Merton as a Theorist

Franco Modigliani and Merton Miller as Theorists

Richard Roll as a Theorist

Theory Summary

CURRENT RESEARCH

Annotated Bibliography

Literature Review Essay

Overview

A Synthesis of Foundational Theory, the CAPM, and the Current Research Annotations.

A Synthesis of the APT and the Current Research Annotations

A Synthesis of Foundational, Primary, and Secondary Theory and the Current Research Annotations

Current Research Summary

APPLICATION

Introduction

Application Essay

Asset Class Attributes, Correlations, and Return Correlations.

Six Points Concerning Asset Class Performance.

The Use of Indices as Benchmarks.

Common Correlation Coefficient Types.

Time Constraints and Securities Portfolios.

Considerations Regarding Securities Portfolio Rebalancing.

Summary

REFERENCES

APPENDIX 1

CURRICULUM VITAE

DISCLAIMER

This text concerns research into economic history and was meant to address the research activity time period of modern portfolio theory (MPT), arbitrage pricing theory (APT), and the capital asset pricing model (CAPM) occurring between the years of 1952 and 1986. An economic history is not intended to be current or future investment recommendations nor is it investment advice. There is nothing contained in this text that should be taken as current or future investment recommendations or investment advice. The entire reason that this text was written and published was to inform and educate the consumer public. Upon reading and understanding the content of this text, if the determination is ever made by the reader, or by anyone with whom the reader makes contact, to invest any money in anything, the reader or assigns should consult with an attorney, stock broker, and CPA—paid professionals who are in place to serve the public who will help you.

DEDICATION

This book is dedicated to the people who ask, Why not? as opposed to those who have made a career from asking simply, Why? No particular text should ever really be considered a "be all" or "end all" with regard to any topic or field of endeavor. The primary impetus behind this text was the novel idea that a text could, or perhaps even should, go beyond the basic Philosophy or Logic course delimiters of Why and Because. Maybe, we could Push-the-Envelope or engage in Out-of-the-Box thinking to ask, Why not? This style of thinking has fostered a tremendous amount of growth over the years for my college students (in several dozens of courses) and, using backward induction, may be a more constructive way of solving all sorts of problems. Try it and see if it works for you. If you are looking for a repository reference that ties together the theory, current research, and application aspects of MPT, APT, and the CAPM in one place—this book is for you.

PREFACE

This book grew from a study project in my doctoral program. Although a doctoral program is generally not for the faint of heart, in my case, my doctoral program was a necessity in order to gain the necessary entrance to professional academics and the resultant academic research and publishing activities. As a professional academic and full-time university professor (70,000+ students—I typically teach graduate students), my duties have evolved to the extent that I have assumed responsibilities in addition to teaching. The predominant activities that account for my time and role are: a role as Subject Matter Expert (SME) for the Field of Finance; a representative to or chair of committees that deal with business and finance learning outcomes and course and curricula development; and service work involving business and finance internally within the university and externally to the community. As a financial economist in public practice, I am called upon by many who continue to view me as the Methodologist of Last Resort, a thorough peer-reviewer for academic journal articles, or as a technical editor for international academic journals. As a former Financial Advisor, I help the industry (after being nominated by other Financial Advisors in the industry to become a sort of federal judge) under the Federal Neutral Arbitrator Act-I am a federal neutral arbitrator who arbitrates disagreements and decides cases involving the input from respondent and claimant legal counsel teams. These cases involve Broker/Dealers, Self-Regulatory Organizations (SROs), or clients of brokerage firms. These observations should be some rationale for why a portion of this text has already appeared in a prominent academic journal. However, this text is the only place to obtain the entire document, from which a portion was already used in that journal, so that it is possible to see the entire source and obtain the rest of the story. The manner of prose in this text is an easy-reading primer on the subject of modern portfolio theory that supports the beginner or seasoned campaigner. Enjoy!

ACKNOWLEDGEMENTS

As a university professor, I can assure you that we always learn the most from the questions asked by our students. In teaching, I am not so much concerned by what students think as opposed to how they think. By engaging in a rigorous regimen of the syllogism and the concomitant logic funnel while writing, supported by Bloom’s Taxonomy, I have enormous confidence in my students, in the realization that success leaves clues, and in the conviction that a provided track to run on will eventually evolve into a personal decision-making process that supports success. To that end, I wanted to acknowledge and thank my previous students (many of whom asked many of the right questions), my previous instructors and professors (who actively engaged me and prompted me when researching and publishing, instead of asking why, to ask why not?), and my many colleagues, friends, family and the leadership of my many fraternal organizations who were always there for me as a support network while I actively engaged in research and publication. My daily efforts reflect an attitude of gratitude. I wanted to take this opportunity to extend my many thanks to the principal faculty, administration, and leadership who smoothed the way and brought me to a large and well-respected university—they are truly the very ones who really make a book like this feasible, probable, and possible. Long after the remains of my progeny have returned to the dust from whence they came, my support network of colleagues and friends will have made possible the conceivable contribution, in some small way, of this text to the body of knowledge we now know as finance and to the Field of Financial Economics. Money is really only a tool and is considered by most active business people and finance professionals to be merely a form of inventory. Always remember—those who have supportive friends are truly among the wealthiest on earth.

ABSTRACT

Theory

The Theory component of this demonstration will include a discussion of the various tenets of modern portfolio theory, foundationally introduced in the writings of Harry Markowitz, and will further include a comparison and contrast of the synthesis of the capital asset pricing model (CAPM) propounded by the four primary CAPM theorists: Jack Treynor, William Sharpe, John Lintner, and Jan Mossin. Arbitrage pricing theory (APT), propounded by Stephen Ross, will be compared and contrasted with the CAPM and further related to the Harry Markowitz foundational theoretical platform of modern portfolio theory. The minor theorists, Fischer Black, Michael Jensen, Myron Scholes, Douglas Breeden, Robert Merton, Merton Miller, Franco Modigliani, and Richard Roll, and their theoretical update contributions, will be evaluated in functional order related to the major theorists’ CAPM work and to the Markowitz work on modern portfolio theory. The demonstration will include an evaluation of the strengths and limitations of the tenets of financial economics, as espoused by the four principal CAPM theorists, Treynor, Sharpe, Lintner, and Mossin, along with Ross’ APT, for the purpose of establishing how the theorists’ cumulative, theoretical work has contributed to the development of the CAPM and APT, and to the development of a platform of values that is useful in financial economics as it relates to asset pricing, asset-specific return, risk and diversification, and to the efficient frontier regarding the construction of securities portfolios.

Current Research

The Current Research component of this demonstration will be comprised of two parts. The first part will be an annotated bibliography of 15 cited sources (i.e., refereed journal articles written in the past three years) around the Theory topic objectives. The second part of the Current Research component will consist of a research literature review essay of some 25 pages on those topic objectives.

Application

The Application demonstration project will consist of the development of a theoretical, overall structure of a presentation that could be used in a specific application to conduct symposia and to act as a financial economics primer for institutional investors and portfolio managers. The Application component will also include a scholarly essay of about 10 pages and will critically evaluate this theoretical presentation of some 25 pages of slides and notes in light of the theories from the Theory section and the research from the Current Research section.

ABOUT THE AUTHOR

Dr. Jewczyn grew up as a farm kid in upstate New York, and after a stint as a radio DJ, served six years in the U.S. Navy as a Navy Corpsman and Pharmacist’s Mate (running the busiest military pharmacy on earth). He completed his baccalaureate degree in 16 months, using the Montgomery G.I. Bill. He earned the degree while working full-time on active duty. After a stint in the Navy’s Sixth Fleet (Admiral’s Staff) on an aircraft carrier as the Pharmacy representative to a Rapid Deployment Surgical Team (the first normalization cruise after the Beirut bombing in 1983 – a diplomatic mission), Dr. Jewczyn completed his Navy tour and became an insurance agent and a securities registered representative for the wealthiest company on earth. For over twenty years, Dr. Jewczyn worked in or around the finance industry as a business owner, business consultant, factor, high net worth (HNW/QIB) Financial Advisor, and an FNAA (FINRA) federal judge, to make sure that investors received good value and that institutions grew more profitable in a regulatory, compliant way. As a student, Dr. Jewczyn has enrolled for and taken over 400 semester hours of classes