Eric Falkenstein, a hedge fund manager in Minneapolis with a PhD in economics, has written a fascinating paper (warning: grad-level economics stuff :)) about risk and return on investments in a world where investors only care about their wealth relative to others and their returns on investment relative to others returns on investment. The rationale for investigating this idea is that:
1. The traditional CAPM (Capital Asset Pricing Model) doesn't have much empirical support - the average rate of return on high beta stocks isn't higher than on low beta stocks.
2. Much research on happiness in economics has shown that beyond a basic subsistence level relative wealth matters more than absolute levels of wealth.
3. The prevalence of index investing and relative return investing. This may have been accompanied by a trend to lower risk premia for stocks, corporate bonds, and other traditionally risky assets over time.
He argues that if all you care about is relative wealth then holding the average market portfolio has zero risk. Deviating from the market portfolio is risky. If this is true then the rate of return on all assets in the market portfolio is equal. There is no extra reward for investing in assets with higher variances of returns compared to the market portfolio whether those risks are correlated with the market portfolio (high beta) or not (idiosyncratic risk). I have yet to work through the implications (except that there is no extra reward for buying and holding stocks in such a world over buying 90 day T-Bills) but if the guy is right he could be on the path to a Nobel Prize in Economics... I understand the paper, but I as I am not a specialist in financial economics I don't know if there are any flaws in his argument which aren't immediately obvious.
3 comments:
I saw your post on iamfacingforeclosure.com.
Earlier today, Casey posted a message with a picture of his "Rich Dad" business address. I _found_ the business (he had blurred out the phone number and vehicle licence plate) but I made use of some interesting information he _forgot_ to delete.
I found the business to be:
Secure Tomorrow-Asset Protctn
(916) 978-4880 3636 Auburn Blvd
Sacramento, CA
The person who runs the business is: Paul Prestwich.
I believe his blog is garbage. A few hours after I posted my comment
"What does Secure Tomorrow - Paul Prestwich have to do with a Roch Dad and real estate?"
He did not post my comment and deleted the picture of his Rich Dads business.
my email address is:
john@johnbordynuik.com
Info about the Rich Dad:
Year Started:
2004
State of Incorporation:
N/A
Location type:
Single Location
Stock Symbol:
N/A
Stock Exchange:
N/A
Trade Style Names:
N/A
SIC Code:
8322-Individual and Family Social Services
Business Description:
Individual/Family Services
Estimated Annual Sales:
$61,000
Estimated Employees:
2
Estimated Employees at Location:
2
Contact Name:
Paul Prestwich
Contact Title:
Principal
you're right it is pure math!!!
The paper is not that bad at all by the standards of academic economics mathwise :)
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