The Case against Stock Picking

Jun 18th, 2015
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The temptation to select specific securities is strong. The temptation flows from the belief that either one has superior insights/research and/or that one contemplates specific approaches to portfolio development with an eye toward a peculiarly beneficial return to risk. There are number of reasons why such temptations should be minimized. The reasons can be shown graphically using the Capital Asset Pricing Model, statistically using Portfolio Theory, empirically using historic evidence and tests, and functionally using the Efficient Market Hypothesis.

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The Case against Stock PickingCharles J. Higgins, Ph.D.Dept. of Finance and Computer Information SystemsLoyola Marymount UniversityOne LMU Dr.Los Angeles, CA 90045-8385310 338 7344chiggins@lmu.eduNovember 13, 20033nd Draft The Case against Stock PickingThis paper brings together various topics in finance-the Capital Asset Pricing Model, Portfolio Theory, the empirical evidence, and the Efficient Market Hypothesis-to address whether individual security selection-Stock Picking-is or is not a meritorious venture.INTRODUCTIONThe temptation to select specific securities is strong. The temptation flows from the belief that either one has superior insights/research and/or that one contemplates specific approaches to portfolio development with an eye toward a peculiarly beneficial return to risk. There are number of reasons why such temptations should be minimized. The reasons can be shown graphically using the Capital Asset Pricing Model, statistically using Portfolio Theory, empirically using historic evidence and tests, and functionally using the Efficient Market Hypothesis.GRAPHICAL DEMONSTRATIONSuperior portfolio construction is generally measured in terms of a generated or expected total return (income plus gains/losses) versus an experienced or contemplated risk. Securities of number n combine into portfolios with a return of: nRp = ? wi Ri (1) i=1where Rp is the return to the portf

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