In 1976 Stephen Ross published an extremely influential article, titled “The Arbitrage Theory of Capital Asset Pricing,” in the Journal of Economic Theory. His “theory,” which is really more of an hypothesis or suggestion, is offered as an alternative to an earlier academic theory, the Capital Asset Pricing Model.

Investors in Ross’s world are the usual academic stick figures, who all have the same information and expectations.  And he appears as eager as his predecessors to use the tools of statistical regression analysis and computer power to make very precise and complex calculations.

Ross’s innovation

What’s new in Ross’s approach is his starting point, which is investor expectations, rather than price outcomes in the movement of actual securities.   Continue reading →