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 choice refers 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 pricing refers to the process by which the prices of financial assets are determined and the resulting relationships between expected returns and the risks associated with those returns in capital markets. Asset pricing theories or models are examples of positive or descriptive economics, since they attempt to describe relationships in the real world. In this book we take the view that these subjects cannot be adequately understood in isolation, for they are inextricably intertwined. As will be shown, asset prices are determined as part of the process through which investors make portfolio choices. Moreover, the appropriate portfolio choice for an individual depends crucially on available expected returns and risks associated with different investment strategies, and these depend on the manner in which asset prices are set. Our goal is to approach these issues more as one subject than as two. Accordingly, the book is intended for those who are interested in descriptions of the opportunities available in capital markets, those who make savings and investment decisions for themselves, and those who provide such services or advice to others.
Academic researchers will find here a series of analyses of capital market conditions that go well beyond simple models that imply portfolio choices clearly inconsistent with observed behavior. A major focus throughout is on the effects on asset pricing when more realistic assumptions are made concerning investors' situations and behavior.
Investment advisors and investment managers will find a set of possible frameworks for making logical decisions, whether or not they believe that asset prices well reflect future prospects. It is crucial that investment professionals