A Discounted View

Bubbles are a naturally occurring phenomenon in financial markets. However, while academics and subscribers to the Efficient Market Hypothesis will argue that a market inefficiency, such as a bubble, could not exist, practitioners  see differently. After all, anyone with money at risk  in their own account or for clients will say that the market did not behave rationally during the recent credit bubble in 2007-2008 or the Dot-com bubble in 1999-2000. Bubbles have existed for centuries with the most infamous dating back to Tulipmania in the 1600’s in Holland. Human nature and our inherent behavioral biases  fuel the rapid rise in asset prices that accompanies a bubble’s expansion phase. This unsustainable growth in investment leads to an eventual dramatic decline that happens nearly as fast the popping of a balloon. While the peak and end of a bubble are easily identifiable in hindsight, the stages of a bubble can be further classified into five chronologi...

The art of professional portfolio management  experienced a revolution after the concepts in Harry Markowitz’s seminal paper explained how investors view risk and return. In his work, he derived formulas used to calculate volatility and expected return of a diversified portfolio with the ultimate goal of his to find the best portfolio allocation to maximize return for a given level of risk. His work is based on three assumptions: 1) Investors are generally risk-averse, 2) investors base their portfolio decisions on risk and expected return only, and 3) investors measure risk as the variance (or standard deviation) of expected returns. The third assumption led Markowitz to conceive the idea of a portfolio being “mean-variance” efficient when no other portfolio offers a higher expected return at a given level of risk, or lower level of risk for a given expected return. Creating portfolios that have higher mean-variance efficiency depends on certain statistical characteristic...