Portfolio Theory This does not mean that early economists ignored financial markets. Irving fisher (1906, 1907, 1930) outlined the basic function of credit market to economic activities, especially as a way of resource allocation, and also recognized the importance of risk in this process. While developing his monetary theory, Keynes (1930, 1936), John Hicks (1934, 1935, 1939), nicholas kaldor (/kloc-0. However, at this early stage, for many economists, correctly speaking, the financial market is still regarded as a pure "casino" rather than a "market". In their view, asset prices mainly depend on the expectation and counter-expectation of capital gains, so they are so-called "self-regulation". The metaphor of john maynard keynes's "beauty pageant" is the representative of this attitude. Therefore, a lot of pen and ink is wasted on the topic of speculation (such as buying/temporarily selling goods or assets for resale in the future). For example, john maynard keynes (1923, 1930) and John Hicks (1939) think that the futures contract delivery price of commodities is generally lower than the expected spot price, which is what Keynes called "normal discount". Keynes and Hicks explained that this was mainly because the hedgers transferred the price risk to the speculators who exchanged the risk premium. Nicholas kaldor (1939) also analyzed the success of speculation on the basis of price stability, and thus extensively expanded Keynes's liquidity preference theory. (In the following years, Holbrooke Woking (1953, 1962) put forward different views that, in fact, there is no difference between the motives of hedgers and speculators. This led to earlier empirical methods competing for the evidence found by Houthakker) (1957, 196 1, 1968, 1969) is beneficial to normal discount; Lester's evidence (Tersse, 1958, 198 1 year) is not conducive to this point. John bull Williams (1938) was one of the first people to challenge the "casino" view of economists on financial markets and asset pricing. He believes that the asset price of financial assets reflects the "endogenous value" of assets, which can be measured by the expected dividend of assets in the discounted cash flow method method. This concept of "fundamental analysis" conforms to irving fisher's theory (1907, 1930) and the practice of "value investment" practitioners, such as Benjamin Graham and others. Harry markowitz (1952, 1959) realized that since the concept of "fundamental analysis" depends on the expected future, risk factors must play a role, so that the new theory of expected utility developed by john von neumann and Oscar Morgenstein (1944) can be greatly utilized. The optimal portfolio selection theory elaborated by markowitz's theory focuses on portfolio diversification as a method to reduce risks under the background of weighing risks and benefits, thus forming the so-called "Modern Portfolio Theory" (MPT). As has been pointed out, the concept of optimal portfolio allocation has been considered by john maynard keynes, John Richard Hicks and nicholas kaldor in their theories. Therefore, Tobin (1958) added monetary theory to markowitz's theory, and thus it was logical to draw the famous "two capital separation theorems". In fact, Tobin believes that market participants will spread their savings between a single portfolio of risk-free assets (funds) and risky assets (in fact, everyone is the same). Tobin insists that different attitudes towards risk will only lead to different combinations of cash and specific risky asset portfolios. Markowitz Tobin's theory is not very practical. Specifically, estimating diversified returns requires practitioners to calculate the return variance of each portfolio. In the CAPM models of William Sharp (1961,1964) and John lintner (1965), they proved that the same effect can be achieved by calculating the variance of each asset relative to the general market index, thus solving this practical difficulty. Using the computing power of the computer to calculate the reduced project ("beta"), the best portfolio selection becomes feasible with the help of the computer. No, no, it's not long since practitioners accepted CAPM model. Another method is the cross CAPM model (1973) (ICAPM) proposed by robert merton. Merton's method and rational expectation hypothesis lead to Cox's, ingersoll's and Ross's partial differential equation of asset price (1985), perhaps only one step away, and robert lucas's asset pricing theory (1978). A more interesting alternative theory is stephen ross's "arbitrage pricing theory" (APT)( 1976). Stephen ross's APT method breaks away from the risk and reward logic of CAPM model and uses the concept of "hedging pricing" to the maximum extent. As Ross himself pointed out, arbitrage theory reasoning is not unique to his theory. In fact, it is the basic logic and method of almost all financial theories. The following famous financial theorem illustrates Ross's point of view. The famous theory of fischer black, Myron Scholes (1973) and robert merton (1973)-option pricing depends largely on arbitrage reasoning. Intuitively, if the option's return choice can be copied by the portfolio or other assets, then the value of the option must be equal to the value of the portfolio, otherwise there will be arbitrage opportunities. M Harrison, David M. Crepps( 1979), DarrellDuffie and Huang Qifu (1985) have also used arbitrage logic to measure the value of various maturity securities (such as "perpetual"). All this permeates the general equilibrium (complete and incomplete) of the new Walras theory, which was put forward by Radner (1967, 1968, 1972) and Oliver D. Hart (1975), the famous Modigliani. This famous theorem of Franco Modigliani and merton miller (1958, 1963) can actually be regarded as a generalization of irving fisher's original "separation theorem" (1930). In fact, Fisher pointed out that in a fully effective capital market, the production decisions of entrepreneurs-owned enterprises should be independent of entrepreneurs' own intertemporal consumption decisions. In other words, the company's profit-maximizing production plan will not be affected by its owner's lending decision, that is, the production plan is independent of the financing decision. Modigliani and merton miller extended this proposition through arbitrage logic. From the perspective of assets, if the basic production plans of enterprises with different financial conditions are the same, then the market value of these companies will be the same, because if they are not the same, there will be arbitrage opportunities. Therefore, regardless of the company's financial structure, arbitrage makes the enterprise value necessarily the same. The second important part of the efficient market hypothesis in finance is the empirical analysis of asset prices. A particularly disturbing conclusion is that prices seem to tend to fluctuate randomly. Specifically, in Louis Cherie (1900) (commodity price), and later Holbrooke Woking (1934) (multiple price series), Alfred Wells (1933, 1937) (). The empirical results of Woking, Cowles and Kendall have always been feared and doubted by economists. If the price is determined by the "supply and demand force", then the price change should be in a special market clearing direction, not random. But not everyone is unhappy to see these results. Many people regard it as evidence that the "fundamental analysis" is wrong, that is, the financial market is really a fanatical casino, so it is not suitable for economic consideration. However, a large group of people have proved that this only shows the failure of the traditional "statistical method", and they can prove nothing. Cliff Granger, Oscar Morgenstein (1963) and Eugene Fama (1965, 1970) used the method of high-performance time series, but the random results were the same. The breakthrough originated from Paul A Samuelson (1965) and benoit Lott (1966). Samuelson's explanation for the findings of Woking, Cowles and Kendall is not that the financial market does not operate according to economic laws, but that it operates too well! The basic concept is simple: if the price changes are not random (and therefore predictable), then any profit-seeking arbitrageur can easily buy and sell assets correctly to take advantage of this. Samuelson and Mandelbrot put forward the famous Efficient Market Hypothesis (EMH), that is, if the market operates normally, all public information about assets (and in some cases private information) will be immediately input into its price. (Note that the word "effective" used here only means that participants make full use of existing information; It does not mention other types of "economic efficiency", such as the effectiveness of resource allocation in production. If the price changes seem random and therefore unpredictable, it is because investors have worked hard: all arbitrage opportunities have been maximized. "Efficient Market Hypothesis" became a household name because of Eugene Fama (1970), and later it was associated with the rational expectation hypothesis of neoclassical macroeconomics. Many practitioners do not like it. Those "technical" traders or "graphic" who think they can predict asset prices by studying the price change pattern don't understand that the efficient market hypothesis tells them that they can't "beat the market" because any existing information is already included in the price. It may also annoy some practitioners of fundamental analysis: the view of efficient market is based on "information" and "confidence", so at least in principle, the possibility of speculative bubbles based on rumors, false information and "group madness" cannot be ruled out. What is even more disturbing is that the efficient market hypothesis does not satisfy economists. Efficient market may be an empirical proposition that can change everything (see robert shiller's criticism (198 1)), but it doesn't seem to have a clear and sound foothold in theory. A special objection can knock it down: that is, if all the information is already included in the price and investors are completely rational, then not only can no one use this information to make a profit, in fact, there will be no transaction at all! Sanford grossman, joseph stiglitz (1980), Paul Milg Rome and Stoke (1982) all demonstrated these conflicts of rational expectation. Intuitively, dissent can be expressed in this way (we have oversimplified it here). The efficient market hypothesis actually means "no free lunch", that is, there will be no hundred-dollar bills on the sidewalk, because if there are, someone has already picked them up. So it is meaningless to look down at the road (especially if there is a cost). However, if everyone thinks so and no one looks down at the road, then any hundred-dollar bill on the ground will not be picked up. But then there will be a hundred-dollar bill on the sidewalk and people will bow their heads. But if everyone realizes this, they will bow their heads and pick up the banknotes, so we go back to the first stage and think that there are no hundred-dollar bills (so it is meaningless to bow our heads). This circular reasoning is the unstable theoretical basis of the efficient market hypothesis.