In business,economics or investment,market liquidity is a market's feature whereby an individual or firm can quickly purchase or sell an asset without causing a drastic change in the asset's price. Liquidity involves the trade-off between the price at which an asset can be sold,and how quickly it can be sold. In a liquid market,the trade-off is mild:one can sell quickly without having to accept a significantly lower price. In a relatively illiquid market,an asset must be discounted in order to sell quickly. Money,or cash,is the most liquid asset because it can be exchanged for goods and services instantly at face value.
Financial economics is the branch of economics characterized by a "concentration on monetary activities",in which "money of one type or another is likely to appear on both sides of a trade". Its concern is thus the interrelation of financial variables,such as share prices,interest rates and exchange rates,as opposed to those concerning the real economy. It has two main areas of focus:asset pricing and corporate finance;the first being the perspective of providers of capital,i.e. investors,and the second of users of capital. It thus provides the theoretical underpinning for much of finance.
In finance,the capital asset pricing model (CAPM) is a model used to determine a theoretically appropriate required rate of return of an asset,to make decisions about adding assets to a well-diversified portfolio.
The efficient-market hypothesis (EMH) is a hypothesis in financial economics that states that asset prices reflect all available information. A direct implication is that it is impossible to "beat the market" consistently on a risk-adjusted basis since market prices should only react to new information.
Eugene Francis "Gene" Fama is an American economist,best known for his empirical work on portfolio theory,asset pricing,and the efficient-market hypothesis.
Market risk is the risk of losses in positions arising from movements in market variables like prices and volatility. There is no unique classification as each classification may refer to different aspects of market risk. Nevertheless,the most commonly used types of market risk are:
A risk premium is a measure of excess return that is required by an individual to compensate being subjected to an increased level of risk. It is used widely in finance and economics,the general definition being the expected risky return less the risk-free return,as demonstrated by the formula below.
In finance,arbitrage pricing theory (APT) is a multi-factor model for asset pricing which relates various macro-economic (systematic) risk variables to the pricing of financial assets. Proposed by economist Stephen Ross in 1976,it is widely believed to be an improved alternative to its predecessor,the capital asset pricing model (CAPM). APT is founded upon the law of one price,which suggests that within an equilibrium market,rational investors will implement arbitrage such that the equilibrium price is eventually realised. As such,APT argues that when opportunities for arbitrage are exhausted in a given period,then the expected return of an asset is a linear function of various factors or theoretical market indices,where sensitivities of each factor is represented by a factor-specific beta coefficient or factor loading. Consequently,it provides traders with an indication of ‘true’asset value and enables exploitation of market discrepancies via arbitrage. The linear factor model structure of the APT is used as the basis for evaluating asset allocation,the performance of managed funds as well as the calculation of cost of capital. Furthermore,the newer APT model is more dynamic being utilised in more theoretical application than the preceding CAPM model. A 1986 article written by Gregory Connor and Robert Korajczyk,utilised the APT framework and applied it to portfolio performance measurement suggesting that the Jensen coefficient is an acceptable measurement of portfolio performance.
The equity premium puzzle refers to the inability of an important class of economic models to explain the average equity risk premium (ERP) provided by a diversified portfolio of equities over that of government bonds,which has been observed for more than 100 years. There is a significant disparity between returns produced by stocks compared to returns produced by government treasury bills. The equity premium puzzle addresses the difficulty in understanding and explaining this disparity. This disparity is calculated using the equity risk premium:
A market anomaly in a financial market is predictability that seems to be inconsistent with theories of asset prices. Standard theories include the capital asset pricing model and the Fama-French Three Factor Model,but a lack of agreement among academics about the proper theory leads many to refer to anomalies without a reference to a benchmark theory. Indeed,many academics simply refer to anomalies as "return predictors",avoiding the problem of defining a benchmark theory.
Momentum investing is a system of buying stocks or other securities that have had high returns over the past three to twelve months,and selling those that have had poor returns over the same period.
The following outline is provided as an overview of and topical guide to finance:
In finance,volatility is the degree of variation of a trading price series over time,usually measured by the standard deviation of logarithmic returns.
A flight-to-quality,or flight-to-safety,is a financial market phenomenon occurring when investors sell what they perceive to be higher-risk investments and purchase safer investments,such as gold and other precious metals. This is considered a sign of fear in the marketplace,as investors seek less risk in exchange for lower profits.
A portfolio manager (PM) is a professional responsible for making investment decisions and carrying out investment activities on behalf of vested individuals or institutions. Clients invest their money into the PM's investment policy for future growth,such as a retirement fund,endowment fund,or education fund. PMs work with a team of analysts and researchers and are responsible for establishing an investment strategy,selecting appropriate investments,and allocating each investment properly towards an investment fund or asset management vehicle.
Financial innovation is the act of creating new financial instruments as well as new financial technologies,institutions,and markets. Recent financial innovations include hedge funds,private equity,weather derivatives,retail-structured products,exchange-traded funds,multi-family offices,and Islamic bonds (Sukuk). The shadow banking system has spawned an array of financial innovations including mortgage-backed securities products and collateralized debt obligations (CDOs).
Portfolio optimization is the process of selecting an optimal portfolio,out of a set of considered portfolios,according to some objective. The objective typically maximizes factors such as expected return,and minimizes costs like financial risk,resulting in a multi-objective optimization problem. Factors being considered may range from tangible to intangible.
In finance,economics,and decision theory,hyperbolic absolute risk aversion (HARA) refers to a type of risk aversion that is particularly convenient to model mathematically and to obtain empirical predictions from. It refers specifically to a property of von Neumann–Morgenstern utility functions,which are typically functions of final wealth,and which describe a decision-maker's degree of satisfaction with the outcome for wealth. The final outcome for wealth is affected both by random variables and by decisions. Decision-makers are assumed to make their decisions so as to maximize the expected value of the utility function.
Chris Brooks is Professor of Finance in the School of Accounting and Finance at the University of Bristol,United Kingdom.
Pim van Vliet is a Dutch fund manager specializing in quantitative investment strategies,with a focus on low-volatility equities. As the head of conservative equities at Robeco Quantitative Investments,van Vliet has contributed to the field through both academic research and practical investment management.
