Modern Portfolio Theory and Investment Analysis (9° Éd.)

Modern Portfolio Theory and Investment Analysis, 9th Editionexamines the characteristics and analysis of individual securities, as well as the theory and practice of optimally combining securities into portfolios. It stresses the economic intuition behind the subject matter while presenting advanced concepts of investment analysis and portfolio management.

The authors present material that captures the state of modern portfolio analysis, general equilibrium theory, and investment analysis in an accessible and intuitive manner.

Part 1 Introduction 1

Chapter 1 Introduction 2

Outline of the Book 2

The Economic Theory of Choice: An Illustration under Certainty 4

Conclusion 8

Multiple Assets and Risk 8

Questions and Problems 9

Bibliography 10

Chapter 2 Financial Securities 11

Types of Marketable Financial Securities 11

The Return Characteristics of Alternative Security Types 19

Stock Market Indexes 21

Bond Market Indexes 22

Conclusion 23

Chapter 3 Financial Markets 24

Trading Mechanics 24

Margin 27

Markets 30

Trade Types and Costs 36

Conclusion 38

Part 2 PORTFOLIO ANALYSIS 39

Section 1 Mean Variance Portfolio Theory 41

Chapter 4 The Characteristics of The Opportunity Set Under Risk 42

Determining the Average Outcome 43

A Measure of Dispersion 44

Variance of Combinations of Assets 47

Characteristics of Portfolios in General 50

Two Concluding Examples 59

Conclusion 62

Questions and Problems 62

Bibliography 64

Chapter 5 Delineating Efficient Portfolios 65

Combinations of Two Risky Assets Revisited: Short Sales Not Allowed 65

The Shape of the Portfolio Possibilities Curve 74

The Efficient Frontier with Riskless Lending and Borrowing 81

Examples and Applications 85

Three Examples 89

Conclusion 92

Questions and Problems 92

Bibliography 93

Chapter 6 Techniques for Calculating The Efficient Frontier 95

Short Sales Allowed with Riskless Lending and Borrowing 96

Short Sales Allowed: No Riskless Lending and Borrowing 100

Riskless Lending and Borrowing with Short Sales Not Allowed 100

No Short Selling and No Riskless Lending and Borrowing 101

The Incorporation of Additional Constraints 102

An Example 103

Conclusion 106

Appendix A: An Alternative Definition of Short Sales 106

Appendix B: Determining the Derivative 107

Appendix C: Solving Systems of Simultaneous Equations 111

Appendix D: A General Solution 114

Appendix E: Quadratic Programming and Kuhn–Tucker Conditions 118

Questions and Problems 121

Bibliography 122

Section 2 Simplifying The Portfolio Selection Process 125

Chapter 7 The Correlation Structure Of Security Returns—The Single-Index Model 126

The Inputs to Portfolio Analysis 127

Single-Index Models: An Overview 128

Characteristics of the Single-Index Model 133

Estimating Beta 135

The Market Model 148

An Example 149

Questions and Problems 150

Bibliography 152

Chapter 8 The Correlation Structure Of Security Returns—Multi-Index Models And Grouping Techniques 155

Multi-index Models 156

Average Correlation Models 162

Mixed Models 163

Fundamental Multi-index Models 163

Conclusion 169

Appendix A: Procedure for Reducing Any Multi-index Model to a

Multi-index Model with Orthogonal Indexes 169

Appendix B: Mean Return, Variance, and Covariance of a Multi-index Model 170

Questions and Problems 172

Bibliography 173

Chapter 9 Simple Techniques for Determining The Efficient Frontier 176

The Single-index Model 177

Security Selection with a Purchasable Index 188

The Constant Correlation Model 189

Other Return Structures 192

An Example 192

Conclusion 193

Appendix A: Single-index Model—Short Sales Allowed 194

Appendix B: Constant Correlation Coefficient—Short Sales Allowed 196

Appendix C: Single-index Model—Short Sales Not Allowed 197

Appendix D: Constant Correlation Coefficient—Short Sales Not Allowed 199

Appendix E: Single-index Model, Short Sales Allowed, and a Market Asset 201

Questions and Problems 201

Bibliography 202

Section 3 Selecting The Optimum Portfolio 205

Chapter 10 Estimating Expected Returns 206

Aggregate Asset Allocation 206

Forecasting Individual Security Returns 212

Portfolio Analysis with Discrete Data 214

Appendix: The Ross Recovery Theorem—A New Approach to

Using Market Data to Calculate Expected Return 215

Bibliography 218

Chapter 11 How to Select Among The Portfolios In The Opportunity Set 220

Choosing Directly 220

An Introduction to Preference Functions 221

Risk Tolerance Functions 224

Safety First 226

Maximizing the Geometric Mean Return 232

Value at Risk (VaR) 234

Utility and the Equity Risk Premium 235

Optimal Investment Strategies with Investor Liabilities 237

Liabilities and Safety-First Portfolio Selection 241

Simulations in Portfolio Choice 241

Conclusion 247

Appendix: The Economic Properties of Utility Functions 247

Relative Risk Aversion and Wealth 249

Questions and Problems 249

Bibliography 250

Section 4 Widening the Selection Universe 255

Chapter 12 International Diversification 256

Historical Background 257

Calculating the Return on Foreign Investments 257

The Risk of Foreign Securities 261

Market Integration 267

Returns from International Diversification 268

The Effect of Exchange Risk 269

Return Expectations and Portfolio Performance 270

Emerging Markets 272

Other Evidence on Internationally Diversified Portfolios 276

Sovereign Funds 278

Models for Managing International Portfolios 280

Conclusion 283

Questions and Problems 284

Bibliography 285

Part 3 Models of Equilibrium in The Capital Markets 289

Chapter 13 The Standard Capital Asset Pricing Model 290

The Assumptions Underlying the Standard Capital Asset Pricing Model (CAPM) 290

The CAPM 291

Prices and the CAPM 300

Conclusion 302

Appendix: Appropriateness of the Single-Period Asset Pricing Model 304

Questions and Problems 308

Bibliography 309

Chapter 14 Nonstandard Forms of Capital Asset Pricing Models 311

Short Sales Disallowed 312

Modifications of Riskless Lending and Borrowing 312

Personal Taxes 322

Nonmarketable Assets 324

Heterogeneous Expectations 326

Non-Price-Taking Behavior 327

Multiperiod CAPM 327

The Multi-beta CAPM 328

Consumption CAPM 328

Conclusion 330

Appendix: Derivation of the General Equilibrium with Taxes 331

Questions and Problems 333

Bibliography 334

Chapter 15 EMPIRICAL TESTS OF EQUILIBRIUM MODELS 340

The Models—Ex Ante Expectations and Ex Post Tests 340

Empirical Tests of the CAPM 341

Testing Some Alternative Forms of the CAPM Model 352

Testing the Posttax Form of the CAPM Model 353

Some Reservations about Traditional Tests of General Equilibrium Relationships and Some New Research 356

Conclusion 358

Questions and Problems 359

Bibliography 360

Chapter 16 The Arbitrage Pricing Model Apt—A Multifactor Approach To Explaining Asset Prices 364

APT—What Is It? 364

Estimating and Testing APT 369

APT and CAPM 381

Recapitulation 382

Term Structure Factor 392

Credit Risk Factor 392

Foreign Exchange [FX] Carry 393

Value Factor 393

Size Factor 393

Momentum Factor 393

Volatility Factor 394

Liquidity Factor 394

Inflation Factor 395

GDP Factor 395

Equity Risk Premium 396

Limitations of Factor Investing 396

Factor Investing Summary 397

Conclusion 397

Appendix A: A Simple Example of Factor Analysis 397

Appendix B: Specification of the APT with an Unobserved Market Factor 399

Questions and Problems 400

Bibliography 401

Part 4 Security Analysis and Portfolio Theory 409

Chapter 17 Efficient Markets 410

Early Development 411

The Next Stages of Theory 412

Recent Theory 414

Some Background 415

Testing the EMH 416

Tests of Return Predictability 417

Tests on Prices and Returns 417

Monthly Patterns 419

Announcement and Price Return 431

Methodology of Event Studies 432

Strong-Form Efficiency 437

Market Rationality 440

Conclusion 442

Questions and Problems 442

Bibliography 443

Chapter 18 The Valuation Process 454

Discounted Cash Flow Models 455

Cross-Sectional Regression Analysis 467

An Ongoing System 471

Conclusion 476

Questions and Problems 476

Bibliography 477

Chapter 19 Earnings Estimation 481

The Elusive Number Called Earnings 481

The Importance of Earnings 484

Characteristics of Earnings and Earnings Forecasts 487

Conclusion 495

Questions and Problems 496

Bibliography 496

Chapter 20 Behavioral Finance, Investor Decision Making, and Asset Prices 499

Prospect Theory and Decision Making under Uncertainty 499

Biases from Laboratory Experiments 502

Summary of Investor Behavior 505

Behavioral Finance and Asset Pricing Theory 506

Bibliography 513

Chapter 21 Interest Rate Theory And The Pricing Of Bonds 517

An Introduction to Debt Securities 518

The Many Definitions of Rates 519

Bond Prices and Spot Rates 526

Determining Spot Rates 528

The Determinants of Bond Prices 530

Collateral Mortgage Obligations 546

The Financial Crisis of 2008 547

Conclusion 549

Appendix A: Special Considerations in Bond Pricing 549

Appendix B: Estimating Spot Rates 550

Appendix C: Calculating Bond Equivalent Yield and Effective Annual Yield 552

Questions and Problems 552

Bibliography 553

Chapter 22 The Management of Bond Portfolios 557

Duration 557

Protecting against Term Structure Shifts 565

Bond Portfolio Management of Yearly Returns 569

Swaps 578

Appendix A: Duration Measures 580

Appendix B: Exact Matching Programs 584

Appendix C: Bond-Swapping Techniques 586

Appendix D: Convexity 587

Questions and Problems 588

Bibliography 589

Chapter 23 Option Pricing Theory 592

Types of Options 592

Some Basic Characteristics of Option Values 598

Valuation Models 603

Artificial or Homemade Options 614

Uses of Options 615

Conclusion 618

Appendix A: Derivation of the Binomial Formula 618

Appendix B: Derivation of the Black–Scholes Formula 621

Questions and Problems 623

Bibliography 624

Chapter 24 The Valuation and Uses of Financial Futures 630

Description of Financial Futures 630

Valuation of Financial Futures 634

The Uses of Financial Futures 639

Nonfinancial Futures and

Commodity Funds 643

Questions and Problems 644

Bibliography 645

Part 5 Evaluating the Investment Process 647

Chapter 25 Mutual Funds 648

Open-End Mutual Funds 649

Closed-End Mutual Funds 652

Exchange-Traded Funds (ETFs) 655

Conclusion 658

Bibliography 658

Chapter 26 Evaluation of Portfolio Performance 660

Evaluation Techniques 661

A Manipulation-Proof Performance Measure 669

Timing 670

Holding Measures of Timing 674

Multi-index Models and Performance Measurement 675

Using Holdings Data to Measure Performance Directly 678

Time-Varying Betas 679

Conditional Models of Performance Measurement, Bayesian Analysis, and Stochastic Discount Factors 679

Bayesian Analysis 680

Stochastic Discount Factors 681

What's a Researcher to Do? 681

Measuring the Performance of Active Bond Funds 682

The Performance of Actively Managed Mutual Funds 682

How Have Mutual Funds Done? 682

The Persistence of Performance 684

Persistence 684

Appendix: The Use of APT Models to Evaluate and Diagnose Performance 689

Questions and Problems 693

Bibliography 693

Chapter 27 Evaluation Of Security Analysis 699

Why the Emphasis on Earnings? 700

The Evaluation of Earnings Forecasts 701

Evaluating the Valuation Process 708

Conclusion 711

Questions and Problems 712

Bibliography 712

Chapter 28 Portfolio Management Revisited 714

Managing Stock Portfolios 715

Active Management 718

Passive Versus Active 719

International Diversification 720

Bond Management 720

Bond and Stock Investment with a Liability Stream 723

Bibliography 728

Index 731

MARTIN J. GRUBER is Nomura Professor of Finance and past Chairman of the Finance Department at the Stern School of Business of New York University. He is a fellow of the American Finance Association. He has published nine books and more than 100 journal articles in journals such as The Journal of Finance, The Review of Financial Studies, Review of Economics and Statistics, Journal of Financial Economics, Journal of Business, Management Science, Journal of Financial and Quantitative Analysis, Operations Research, Oxford Economic Papers, and The Journal of Portfolio Management. He has been coeditor of the Journal of Finance. He has been President of the American Finance Association, a Director of the European Finance Association, a Director of th