by Peter L Bernstein
This book is in our opinion one of the best books on how to understand the five fundamental investment ideas for the modern era investor.
Capital Ideas Evolving by Peter L. Bernstein helps explain how the five fundamental investments ideas from the mid-twentieth century have shaped how we view investments. The ideas have withstood scrutiny and derision and have actually been enhanced by the numerous challenges they have faced, most notably by the behavioralists of the late twentieth century.
5 Fundamental Investment Ideas that Changed Investor Viewpoints
Bernstein does a wonderful job of telling the story of how the five fundamental investment ideas evolved in the mid twentieth century. He very eloquently explains to the investor reader how each of the human players developed the various five fundamental ideas (some of whom won Nobel Prizes for their work). It cannot be overstated how radical these five investment ideas were at the time.
The 5 fundamental investment ideas are:
- Harry Markowitz - Portfolio Selection Theory based on risk
- Modigliani & Miller - Theory of Capital Structure
- Bill Sharpe - Capital Asset Pricing Model (CAPM)
- Eugene Fama - Efficient Market Hypothesis
- Merton-Black-Scholes - Theory of Option Pricing
Each of these 5 fundamental investment ideas is briefly discussed below.
Harry Markowitz - Portfolio Selection Theory based on risk
Harry Markowitz’s radical investment approach of the day changed the fundamental assumptions made by investors. The Portfolio Theory emphasised the importance of risk in the portfolio of investments made by an investor.
Modigliani & Miller - Theory of Capital Structure
Nobel winners Franco Modigliani and Merton Miller again challenged conventional ideas of the time by the assumption that it did not matter how a company was financed. Modigliani and Miller believe that the value of the company is the same if it is valued by debt (borrowings) or equity (shareholder investment).
Capital Asset Pricing Model (CAPM)
Nobel winner Bill Sharpe’s Capital Asset Pricing Model (CAPM) emphasised that capital prices do in fact reflect investment risk. CAPM explains how some types of risk are investment specific and can be diversified away by the investor. This is referred to in the theory as “alpha”. The other type of risk “beta” is based on the whole investment and cannot be diversified away.
Eugene Fama - Efficient Market Hypothesis
Eugene Fama’s idea on the efficient market hypothesis assumes that the price of an investment is already based on all known knowledge. It therefore implies investors will not be able to beat the market (since if the investor knows something, that knowledge is already priced into the stock value).
Merton-Black-Scholes - Theory of Option Pricing
Fischer Black, Myron Scholes and Robert Merton created the theory of option pricing, which enabled the market to have a theoretical basis for creating more complicated derivatives.
Summary Review of Capital Ideas Evolving
Capital Ideas Evolving manages to deliver its informative and educational messages in a very clear and concise way. As a consequence Peter L. Bernstein has delivered essential investor reading.
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