Finance's Wrong Turns: A New Foundation for Financial Markets, Asset Management, and Social Science

Preface
Economic Theory Status
Social Science and the Workbench
Overview
Analytical Requirements
Acknowledgments
Contents
About the Author
List of Figures
1 The Birth of Modern Finance
	Rational Investing
	Birth of Modern Finance
	The Markowitz MV Efficient Frontier
	A Different Narrative
	The Critical Line Algorithm
	Scientific Investment Management
	Well-Defined Investment Programs—A Technical Note
	References
2 Capital Market Theory and Efficient Markets
	Capital Asset Pricing Model (CAPM)
	CAPM Utility Assumptions
	CAPM Formulas
	CAPM Status
	Practical Implications
	Efficient Markets Hypothesis
	An Academy-Workbench Truce
	References
3 Rise of Institutional Quantitative Asset Management
	The Institutional Asset Management Framework
	The Sharpe (1963) Market Line Model
	The Importance of Beta
	Institutional Quantitative Equity Portfolio Practice
	Ross APT Risk Model
	Fama-French Risk Model
	Principal Component Analysis Risk Models
	Long-Short MV Optimization
	The Index Fund Question
	Roll (1992) Critique
	Merton’s (1987) Information Cost MV Efficiency
	Institutional Quantitative Return Estimation
	Long-Term Factors and Practical Value
	The Dividend Discount Model (DDM)
	Testing the DDM
	Multiple Valuation Models
	A Forward Test
	Modern Statistical Estimation
	Hensel et al. (1991) and the Manager Irrelevance Fallacy
	Institutional Active Management Status
	References
4 Finance Theory in Crisis
	CAPM Theory Redux
	VM Rationality Framework
	The Allais Paradox
	Kahneman and Tversky Gains and Losses
	Roots in the 1930s Crisis in Mathematics
	Resolutions
	Consilience
	Conclusion
	References
5 The Crisis at the Workbench
	Markowitz Optimization as the Institutional Standard
		Strategies in Widespread Practice
	A Simple Example
	Operations Research and Investment Management
	Demonstrating MV Optimization Instability
	Comment on the JK Simulation Framework
	Fundamental Implications of the JK Experiment
	Black-Litterman Optimization
	Out-of-Sample Linear Constrained MV Optimization
	Information Level, Universe Size, and the Fundamental Law
	Markowitz’s Revenge
	The Role of the Market Portfolio in Theory and Practice
	Summary
	Appendix
	References
6 The Michaud Efficient Frontier and Expected Utility
	Instability in Markowitz MV Optimization
	Min and Max Michaud Efficient Portfolios
	The Equal-Return-Rank (ERR) Algorithm
	The Michaud Frontier in Theory
	Michaud Better Diversification?
	A Foundation for Portfolio Resampling
	Back Test Limitations
	Efficient Frontier Simulation Tests
	The Markowitz-Usmen Challenge
	Different Levels of Investment Information
	Investment Uncertainty
	The Necessity of the Forecast Uncertainty Parameter
	Can Michaud Optimization Fail
	A Distribution-Free Mean–Variance Efficient Frontier
	Expected Utility and the Michaud Efficient Frontier
	Markowitz 2005 Efficient Frontier Triangle
	Michaud Is not Markowitz
	Summary
	References
7 An Enhanced Investment Process
	Portfolio Rebalancing in Practice
	Portfolio Statistical Similarity
	A Practical Portfolio Similarity Test
	Similarity Test Enhancements
	Note on Simulation Research
	A Note on Optimization and Multivariate Linear Regression
	Simulation and Optimized Portfolio Analysis
	Trade Advisor
	Enhancements
	Implications for Asset Management
	References
8 A New Foundation for Financial Markets and Social Science
	Knight Uncertainty
	Keynes Speculative Markets
	Markowitz (1952) and Investing Norms
	The Prisoner’s Dilemma
	Multiperiod Character of Cooperative Social Norms
	Social Norm Stability
	Pure Coordination Games Rationality
	Local Market Equilibrium
	Stock Market Evolutionary Norms
	Sources for Financial Conventions
	Negative and Positive Feedback Markets
	Fair Exchange
	Liquid Market Rationality
	The Stock Market as a Unique Financial Intermediary
	Investor Risk Aversion
	Security Relative Valuation
	Statistical Nature of Evolutionary Social Markets
	Conclusions
	Summary
	References
Epilogue
Preference Theory
A Sociological Context
References
Index