Re-Evaluating the Value of Modern Portfolio Theory and Asset Pricing Models Based on Behavioral Insights from Benjamin Graham's Value Investing Paradigm
33 Pages Posted: 5 Jun 2017
Date Written: June 3, 2017
Modern Portfolio Theory, the Capital Asset Pricing Model, and the Efficient Market Hypothesis are cornerstone concepts in both academic and professional curricula. In spite of their long history and reputation, the CAPM and its extensions do not yield satisfactory empirical results. We argue that this is because these models ignore the impact of human behavior in financial markets. We present a critique of these standard models using behavioral insights from Benjamin Graham’s value investing paradigm. We propose that if, instead of getting fixated on investors’ optimal rational decision making, we adopt Benjamin Graham’s value investing perspective which explicitly acknowledges that investor decision making is by definition imperfect due to psychological biases, we could derive better investment decision making processes.
Keywords: Modern Portfolio Theory, Capital Asset Pricing Model, Efficient Market Hypothesis, Benjamin Graham, Value Investing, Behavioral Finance
JEL Classification: G02, G11, G12, G14
Suggested Citation: Suggested Citation