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Sunday: Westman on Investment Theory
SUNDAY - JULY 15TH, 4:00 p.m., Pellissippi State Technical Community College
"Rationalism in Investment Theory," by Carl Westman



[Abstract]

One of the key assumptions of modern portfolio theory is that all investors act rationally. But what does it mean to be rational? Legendary investor Warren Buffett (an agnostic!) has long advocated that investors select securities whose market price is less than their intrinsic value. This seems quite rational. However, the vast majority of academic studies on market efficiency have found that securities are almost always fairly priced, incorporating new information so rapidly that even professional money managers cannot exploit pricing anomalies with any regularity.

Empirical evidence bears this out: year after year, most professional money managers fail to best the return of the broad market averages. As for the managers who will beat the market, the difficulty is identifying them in advance. As a result, conventional wisdom is to piggyback on market efficiency and put one’s stock investments in market index funds. From this perspective, it is rational to not play a game (active stock-picking) that you can’t win in the long run.

But is it rational to blindly invest in securities, or an index fund of securities, with absolutely no regard to price and risk? What happened to buy low, sell high? Without a rational view of the intrinsic value of a security, how can index investors avoid market bubbles, irrational exuberance, and other modern day forms of Tulipmania? How can an ordinary investor resolve these competing theories?

Carl will present the main arguments on both sides of the active vs. passive investing debate, and then propose a synthesis.

[Carl is an actuary and financial analyst from Chattanooga.]






Posted by pking
July 14, 2007