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Full Description
An innovative guide to finding alpha in a world where risk usually does not correlate with higher returns Finding Alpha is a practical guide to achieving alpha when conventional measures of risk rarely correlate with higher returns. To start, author Eric Falkenstein--a PhD who has also been a risk manager and portfolio manager--walks readers through the Capital Asset Pricing Model (CAPM), as well as other well-documented theories about risk and return, and explores how these theories measure up to current empirical evidence being documented by researchers and academics. Rounding out the discussion, Falkenstein outlines prominent real examples of alpha in finance, and how the search for alpha affects the day-to-day life of all finance professionals. Eric Falkenstein, PhD (Eden Prairie, MN), developed RiskCalc TM, the world's leading scoring tool for evaluating private firm default risk, while at Moody's Risk Management Services.
Contents
CHAPTER 1 Risk Uncorrelated with Returns. The Response(Return)). Failed Paradigms. You Minimize Some Risks, Pay to Take Others. CHAPTER 2 The Creation of the Standard Risk-Return Model. The CAPM. Pillar 1: Decreasing Marginal Utility Means Risk Aversion. Pillar 2: Diversification Means Not All Risk Is the Same. The Arbitrage Pricing Theory (APT). The Stochastic Discount Factor (SDF). Adding Non-Normality. The Uncertainty Revival. CAPM: A Special Case of the Stochastic Discount Factor Model. CHAPTER 3 An Empirical Arc. The Beginning of the End of CAPM. APT Tests. Fama and French Put a Fork in the CAPM. Saving the Standard Model. Serial Changes to APT. Skewness. Analogy to Business Cycle Forecasting. Summary. CHAPTER 4 Volatility, Risk, and Returns. Total Volatility and Cross-Sectional Returns. Beta-Sorted Portfolios. Call Options. Small Business. Leverage. Mutual Funds. Futures. Currencies. Lotteries. Movies. World Country Returns. Corporate Bonds. The Long End of the Yield Curve. Distress Risk. Sports Books. Total Volatility and Expected Equity Index Returns. Uncertainty and Returns. IPOs. Trading Volume. Volatility as Shorthand for Risk. CHAPTER 5 Investors Do Not Mind Their Utility Functions. Behavioral Violation 1: Investors Trade Too Much. Behavioral Violation 2: Too Many Funds. Behavioral Violation 3: Underdiversification. Behavioral Violation 4: No Fundamental Analysis. Behavioral Violation 5: Buy Recommendations Exclude Firms with Merely Low Risk. Behavioral Violation 6: Agents Do Not Agree. Behavioral Violation 7: The Home Bias. The Rotten Core: The Utility Function. Absurd Extrapolations. Easterlin's Paradox. Summary. CHAPTER 6 Is The Equity Risk Premium Zero? Geometric versus Arithmetic Averaging. Survivorship Bias. Peso Problems. One-time Effect of an Anomalous Post-Depression Period. Asymmetric Tax Effects. Market Timing. Transaction Costs. Summary. CHAPTER 7 Undiminished Praise of a Vacuous Theory. CHAPTER 8 Why Relative Utility Generates Zero-Risk Premiums. Benchmark Risk. Why Relative Risk Leads to No Risk Premium. CHAPTER 9 Why We Are Inveterate Benchmarkers. Typical Economic Assumptions. Virtue of Selfishness. Why Envy Is Virtuous. Why Economists Dislike Envy in General. CHAPTER 10 Alpha, Risk, and Hope. The Search for Safety. Most Financial Risk Takers Are Foolish. Two Types of Priced Risk. Uncertainty in Innovation. Why Risk Taking Hurts. Confusion of Risk and Gambling. Standard Alpha Contradiction. Why We Take Risk Anyway. Experiments, Risk, and Alpha. CHAPTER 11 Examples of Alpha. Finding the Right Alpha. Arbitraging Put-Call Parity. Convexity Trade in Futures and Swaps. Pairs and Mean Reversion. Fund Innovations. Convertible Bonds. Long and Short Equity Hedge Funds. Automating Activities. Conclusion. CHAPTER 12 Alpha Games. Benign Deception. The Favor Bank. Managerial Alpha. The Alpha in Risk Management. A Singular Risk Management Decision. Risk Management Like Audit. Overpaid Alpha Deceptors. Investor Meets Alpha. CHAPTER 13 Alpha Seeking Applications. Minimum Volatility Portfolio. Beta Arbitrage. Investing in Anomalies. Safety Investing. Hope Investing. Relative Risk and Bubbles. Capital Finding Alpha Strategies. Search for Alpha. CHAPTER 14 Conclusion. Notes. Index.
