An Updated View of Risk & Return
Introduction (Via Falken Blog)
I think my paper is superior to the standard Corporate Finance course you will learn in college or graduate school. This is because they neglect to mention the fundamental theory that risk and expected return are positively correlated, is an empirical failure. Professors have been very successful at presenting the CAPM and its spawn as a triumph of the social sciences, in a way similar to how macroeconomists used to present Keynesian macro models before the Phillips curve started to do multiple backflips. The profs are filled with wishful thinking based on ever more obscure econometric tests that prove their big idea works, a science no less than thermodynamics. It doesn’t work, not even as an approximation. You have a finite life, don’t waste it on theories theories popular among professors but not practitioners.
Abstract (via Eric Falkenstein)
Empirically, standard, intuitive measures of risk like volatility and beta do not generate a positive correlation with average returns in most asset classes. It is possible that risk, however defined, is not positively related to return as an equilibrium in asset markets. This paper presents a survey of data across 20 different asset classes, and presents a model highlighting the assumptions consistent with no risk premium. The key is that when agents are concerned about relative wealth, risk taking is then deviating from the consensus or market portfolio. In this environment, all risk becomes like idiosyncratic risk in the standard model, avoidable so unpriced.