The Relative Value Theory
AbstractI propose the following theory: rational investors allocate capital to maximize the probability-weighted geometric mean of payoffs. I present the theory’s rationale and investigate its implications. I find that diversification increases cumulative returns and asset values are relative. The theory does not make assumptions about investors’ risk preferences and explains the “risk premium” without using the utility function concept. In a world of rational, risk indifferent investors the market tends to a stable equilibrium characterized by all investors holding the market. I calculate equilibrium prices for a simple model. The theory uses a unique discount rate (to account for time value of money) and ignores the required rate of return concept. The theory addresses some of the CAPM’s inconsistencies. I conclude the theory is coherent and useful in explaining observable finance phenomena.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by EconWPA in its series Finance with number 0106003.
Date of creation: 02 Jul 2001
Date of revision:
Note: Type of Document - Word XP; prepared on PC (IBM compatible);
Contact details of provider:
Web page: http://220.127.116.11
asset valuation risk rationality CAPM RVT stock market equilibrium;
Find related papers by JEL classification:
- G - Financial Economics
This paper has been announced in the following NEP Reports:
- NEP-ALL-2001-07-13 (All new papers)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, 09.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (EconWPA).
If references are entirely missing, you can add them using this form.