Realitivity in Finance

1. REALITY 1 – Goals are stochastic (e.g., pension liabilities) – and not “Background Risk”, “Habit” or “KUJ” or deterministic as in CAPM
2. REALITY 2- Investors have multiple stochastic goals (retirement, kid’s education, post-retirement health) and not just 1.
3. RELATIVITY 1 – Investors maximize goal-relative risk-adjusted returns – and not “Epstein-Zin” utility functions! or additive utility functions.
4. RELATIVITY 2 – They hire agents/ #assetmanagers to manage portfolios (delegation at many levels – a Board to an investment team; the team to asset managers – passive or active)
5. REALITY/RELATIVITY 3 – They want (hopefully) skillful agents – largely ignored in the literature. So can’t use #Sharpe ratios but must use #Mcube.
6. REALITY 4 – They specify risk through an absolute volatility and a target #trackingerror in their #investment Policy Statements – and not some random/arbitrary “risk aversion” parameter.
REALITY 5 – An effective asset pricing model should also provide consistent #assetallocation and risk-adjusted performance measures to be useful – only #capm does this; 99% of other asset pricing models fail this test (e.g., APT ).

Collaborators

By

DR. ARUN MURALIDHAR

Dr. Sunghwan Shin, PhD, is former President of Korea Institute of Finance, member of the MIT Sloan Golub Center for Finance and Policy Advisory Board and Professor at Hongik University in Seoul, Korea;

https://www.researchgate.net/profile/Sunghwan_Shin

Dr. Kazuhiko Ohashi, PhD, is Professor of Finance, Graduate School of International Corporate Strategy (ICS), at Hitotsubashi University in Tokyo, Japan.

https://hri.ad.hit-u.ac.jp/html/325_profile_en.html

Dr. Robert C. Merton, PhD, recipient of the 1997 Alfred Nobel Memorial Prize in Economic Sciences, is the School of Management Distinguished Professor of Finance at the MIT Sloan School of Management. He is also Resident Scientist at Dimensional Fund Advisors, a Texas-based global asset management firm, and University Professor Emeritus at Harvard University.

https://mitsloan.mit.edu/faculty/directory/robert-c-merton

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