Portfolio Theory, CAPM and Performance Measures

Abstract

This chapter is focused on the “Portfolio Theory” created by Markowitz. This theory has the objective of finding the optimum portfolio for investors; that is, that which gives tangency between an indifference curve and the efficient frontier. In this chapter, the mathematics of this model is developed. The CAPM, based on this theory, gives the expected return on an asset depending on the systematic risk of the asset. This model detects underpriced and overpriced assets. The critics expressed against the model and their application possibilities are also analyzed. Finally, the chapter centers on performance measures related to portfolio theory (classic indices, derivative indices and new approaches) and on the performance persistence phenomenon employing the aforementioned indices, including an empirical example.