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An Analytic Derivation of the Efficient Market Portfolio

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  • Zion Guo

    ()
    (Department of Business Education, College of Technology, National Changhua University of Education, 500, Changhua, Taiwan, R.O.C.)

  • Hsin-Yi Huang

    (C., Tel.: 886-4-7232105 ext.7344; Fax: 886-4-7211290, E-mail: zionguo@cc.ncue.edu.tw.)

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    Abstract

    A market portfolio plays an important role in many financial theories and models. It is at the heart of the capital asset pricing model and other multivariate models. Because of the market portfolio cannot be observed directly, proxy portfolios must be used to conduct empirical studies. Unfortunately, many studies found these proxies to be inefficient and even removed from the efficient frontier. According to two-fund separation theorem, we take two steps to discover the efficient market portfolio. Our thinking is straightforward and proves that our market portfolio is not only an efficient portfolio but also is situated on the capital market line. Many researches have shown that the market portfolio is extremely sensitive to performance measurements. Hence, our findings may significantly influence financial research.

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    File URL: http://www.ipe.ro/rjef/rjef4_12/rjef4_2012p104-116.pdf
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    Bibliographic Info

    Article provided by Institute for Economic Forecasting in its journal Romanian Journal for Economic Forecasting.

    Volume (Year): (2012)
    Issue (Month): 4 (December)
    Pages: 104-116

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    Handle: RePEc:rjr:romjef:v::y:2012:i:4:p:104-116

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    Related research

    Keywords: asset allocation; two-fund separation; capital market line; HJB equation; dynamic programming setting;

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    1. MacKinlay, A Craig & Richardson, Matthew P, 1991. " Using Generalized Method of Moments to Test Mean-Variance Efficiency," Journal of Finance, American Finance Association, vol. 46(2), pages 511-27, June.
    2. Soosung Hwang & Stephen Satchell, 2002. "Calculating the misspecification in beta from using a proxy for the market portfolio," Applied Financial Economics, Taylor & Francis Journals, vol. 12(11), pages 771-781.
    3. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August.
    4. Dybvig, Philip H & Ross, Stephen A, 1985. " The Analytics of Performance Measurement Using a Security Market Line," Journal of Finance, American Finance Association, vol. 40(2), pages 401-16, June.
    5. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
    6. Ravi Jagannathan & Tongshu Ma, 2003. "Risk Reduction in Large Portfolios: Why Imposing the Wrong Constraints Helps," Journal of Finance, American Finance Association, vol. 58(4), pages 1651-1684, 08.
    7. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
    8. Gibbons, Michael R & Ross, Stephen A & Shanken, Jay, 1989. "A Test of the Efficiency of a Given Portfolio," Econometrica, Econometric Society, vol. 57(5), pages 1121-52, September.
    9. Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
    10. Green, Richard C, 1986. " Benchmark Portfolio Inefficiency and Deviations from the Security Market Line," Journal of Finance, American Finance Association, vol. 41(2), pages 295-312, June.
    11. Roll, Richard, 1978. "Ambiguity when Performance is Measured by the Securities Market Line," Journal of Finance, American Finance Association, vol. 33(4), pages 1051-69, September.
    12. Kandel, Shmuel & Stambaugh, Robert F., 1987. "On correlations and inferences about mean-variance efficiency," Journal of Financial Economics, Elsevier, vol. 18(1), pages 61-90, March.
    13. Green, Richard C & Hollifield, Burton, 1992. " When Will Mean-Variance Efficient Portfolios Be Well Diversified?," Journal of Finance, American Finance Association, vol. 47(5), pages 1785-809, December.
    14. Jobson, J. D. & Korkie, Bob, 1982. "Potential performance and tests of portfolio efficiency," Journal of Financial Economics, Elsevier, vol. 10(4), pages 433-466, December.
    15. Levy, Haim, 1983. "The Capital Asset Pricing Model: Theory and Empiricism," Economic Journal, Royal Economic Society, vol. 93(369), pages 145-65, March.
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