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Investors and Markets

Investors and Markets: Portfolio Choices, Asset Prices, and Investment Advice

William F. Sharpe
Copyright Date: 2007
Edition: STU - Student edition
Pages: 232
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  • Book Info
    Investors and Markets
    Book Description:

    InInvestors and Markets, Nobel Prize-winning financial economist William Sharpe shows that investment professionals cannot make good portfolio choices unless they understand the determinants of asset prices. But until now asset-price analysis has largely been inaccessible to everyone except PhDs in financial economics. In this book, Sharpe changes that by setting out his state-of-the-art approach to asset pricing in a nonmathematical form that will be comprehensible to a broad range of investment professionals, including investment advisors, money managers, and financial analysts. Bridging the gap between the best financial theory and investment practice,Investors and Marketswill help investment professionals make better portfolio choices by being smarter about asset prices.

    Based on Sharpe's Princeton Lectures in Finance,Investors and Marketspresents a method of analyzing asset prices that accounts for the real behavior of investors. Sharpe makes this technique accessible through a new, one-of-a-kind computer program (available for free on his Web site, at that enables users to create virtual markets, setting the starting conditions and then allowing trading until equilibrium is reached and trading stops. Program users can then analyze the final portfolios and asset prices, see expected returns, and measure risk.

    In addition to popularizing the most sophisticated form of asset-price analysis,Investors and Marketssummarizes much of Sharpe's most important previous work and reflects a lifetime of thinking about investing by one of the leading minds in financial economics. Any serious investment professional will benefit from Sharpe's unique insights.

    eISBN: 978-1-4008-3018-3
    Subjects: Finance

Table of Contents

  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-vi)
    (pp. vii-x)
    (pp. 1-8)

    THIS IS A BOOK about the effects of investors interacting in capital markets and the implications for those who advise individuals concerning savings and investment decisions. The subjects are often considered separately under titles such as portfolio choice and asset pricing.

    Portfolio choicerefers to the ways in which investors do or should make decisions concerning savings and investments. Applications that are intended to describe what investors do are examples of positive economics. Far more common, however, are normative applications, designed to prescribe what investors should do.

    Asset pricingrefers to the process by which the prices of financial assets...

    (pp. 9-34)

    THIS CHAPTER SHOWS how equilibrium can be reached in a capital market and describes the characteristics of such an equilibrium. We present a series of cases, each of which assumesagreementamong investors concerning the chances of alternative future outcomes. More complex (and realistic) cases are covered in later chapters.

    A standard definition of equilibrium is:

    A condition in which all acting influences are canceled by others, resulting in a stable, balanced or unchanging system.*

    We will use a much simpler definition:a financial economy is in equilibrium when no further trades can be made. But of course in the...

    (pp. 35-62)

    THE TRADING PROCESS used in Case 1 involved a number of markets. In each, the market maker asked Mario and Hue to indicate their reservation prices for a specific security, and then to denote the number of shares they would be willing to buy or sell at an announced price based on those reservation prices. We characterized Mario and Hue’s behavior as consistent with downward-sloping demand curves and upward-sloping supply curves. We also represented each of them as having atime preferenceand arisk aversion. This was, at best, an opaque description of their preferences. In this chapter, we...

    (pp. 63-110)

    THIS CHAPTER FOCUSES on prices—the prices of both securities and the state claims introduced in Chapter 3. Of particular interest are the relationships among expected returns, various measures of risk, and measures of responsiveness to changes in market-wide variables. We introduce alternative versions of the Market Risk/Reward Theorem (MRRT) and investigate the conditions under which one or more version may hold. As in previous chapters, we assume that investors agree on the probabilities of future states, have no outside positions, and discount the utilities from all states at a given time in the same way, leaving for future chapters...

    (pp. 111-128)

    IN THE CASES that we have analyzed thus far, investors exhibited substantial diversity. They held different initial portfolios and had different marginal utility functions. On the other hand, they were alike in a number of respects. Most important, they all agreed on the probabilities of future states of the world. Moreover, none had sources of consumption outside the financial markets. Finally, none favored any future state over another—more specifically, for each investor the marginal utilities of consumption in future states with the same consumption were the same.

    In this chapter, we investigate cases in which investors are more diverse....

    (pp. 129-148)

    ALL OUR PREVIOUS CASES had one common aspect: investors agreed on the probabilities of future states. While people chose to hold different portfolios, in an important sense all their actions were based on the same predictions. There was no distinction between what our investors did and what they should have done. They correctly chose different portfolios because they had different preferences and/or positions.

    Anyone who has observed or participated in the investment world knows that the assumption of agreement is a fanciful representation of reality. Much of the behavior of real investors can be explained only by acknowledging that they...

    (pp. 149-184)

    SHOULD ONE INVEST in stocks or in bonds? Stocks haveupside potential, generating higher returns if markets go up. But they can generate losses if markets go down. Bonds offerdownside protection, providing interest and principal repayment if held to maturity (absent default). But in good market environments, bonds generally underperform stocks. Wouldn’t it be splendid if an investment offered both upside potential and downside protection? There are such investments and we will have much to say about them in this chapter. We will call themprotected investment products, orPIPs.

    Of course, in an efficient capital market one never...

    (pp. 185-212)

    MOST OF THIS BOOK has focused on positive economics. We have created investors; given them preferences, predictions, and positions; let them trade with a set of available securities until they would trade no more; and then examined the relationships among security and portfolio prices, expected returns, and various measures of risk. Our focus was on the properties of equilibrium in capital markets.

    But the actors in our plays made normative decisions as they sought to maximize their expected utilities. And they made these decisions by themselves. In the real world, only a minority of investors can and should attempt such...

    (pp. 213-214)
  13. INDEX
    (pp. 215-221)