Chapter 9 – A New Walking Shoe: Modern Portfolio Theory I. Introduction a. Modern Portfolio Theory (MPT) came about as a result of all the controversy in the academic world about the theories commonly used by professionals (such as the firm-foundation and castle in the air theories) II. The Role of Risk a. Efficient market theory explains that the random walk is possible. i. The stock market is so good at adjusting to new information that no one can predict its future course in a superior manner ii. Because the pros are constantly taking action to react to available news, the odds of selecting superior stocks are even (you, a stockbroker, and an ape have the same chance of “beating the market”) b. But common sense attests that some people can and do beat the market. c. Risk, and risk alone, determines the degree to which returns will be above or below average, and thus decides the valuation of any stock relative to the market III. Defining Risk: The Dispersion of Returns a. Investment Risk:
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