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CAPM: Past, Present, And Future Financial Thinking

CAPM: Past, Present, And Future Financial Thinking  by William F. Sharpe and Robert Litterman, CFA Institute.


At the 67th CFA Institute Annual Conference, held 4–7 May 2014 in Seattle, Robert Litterman interviewed William F. Sharpe to elicit his perspective on a number of investment issues, including the capital asset pricing model, asset allocation, behavioral finance, and retirement income.

CAPM: Past, Present, And Future Financial Thinking  – Introduction

Litterman: One of the best opportunities for me in my role working with CFA Institute is the opportunity to participate at conferences. This is the third year in a row that I’ve had the distinct pleasure of interviewing a Nobel Laureate. Joining me today is Bill Sharpe. Bill, perhaps you could start by discussing the intellectual environment that caused you to do the research that led to the capital asset pricing model (CAPM).

Sharpe: I was working at the RAND Corporation, which was an absolutely fabulous place, intellectually, and I was also working fulltime on my PhD at the University of California, Los Angeles (UCLA), which RAND made very easy to do. At UCLA, I was influenced primarily by two key people: Armen Alchian of the economics department and Fred Weston of the business school. RAND was also a major influence because it was a pioneer in linear programming and operations research and had serious computing power.

Litterman: Was Harry Markowitz at RAND at the same time?

Sharpe: Harry came after I had been there a while. I won’t bore you with the story, but I had started another dissertation, and I thought I was halfway finished when the chap at UCLA whose work I was extending said he didn’t believe there was a dissertation there. Then Fred Weston said, “Well, Harry Markowitz just came to RAND. You like his work. Why don’t you go talk to Harry?”

Litterman: Correct me if I’m wrong, but many groundbreaking papers were rejected when first submitted to journals, and I believe that was also true with the CAPM paper (Sharpe 1964).

Sharpe: It certainly was. I submitted it in early 1962, and it was promptly rejected. The referee said that the CAPM makes “unrealistic assumptions,” but I was taught that all models make unrealistic assumptions. It did not seem fair, so I appealed the decision. It was finally published in 1964, when there were some different referees and a different editor. Later, I learned the identity of the referee who had suggested rejection—one of the nicest people ever. He was at UCLA, and we remained good friends after all this was revealed.

Litterman: Did you have any clue at the time how important, how seminal, this work was?

Sharpe: Yes and no. I didn’t know how good it was, but I did know—and I believe time has proven me correct—that it was undoubtedly the best paper I was ever going to write.

And I remember sitting by the phone, waiting for a phone call, and nothing happened. I later discovered that in that era, people didn’t read finance journals right away; they often waited a year or two. So, it was quite a while before the paper began to attract attention.

Litterman: Throughout your career, your development has focused on very practical issues associated with asset allocation, style attribution, the Sharpe ratio, and so on. Could you talk about that?

Sharpe: The phrase I like to employ is “useful theory.” I have always worked with that goal, and I believe it came in large part from Armen Alchian and Fred Weston, as I mentioned, and, of course, from what was going on at RAND early in my career.

Litterman: Your research has been very practical. I would also say that it seems to focus very much on using computers, even in the earliest days. I saw in your curriculum vitae something about having written a book on BASIC (beginner’s all-purpose symbolic instruction code) programming around the time when you were developing the CAPM. You also wrote something about airport transport or something like that.

See full article here by CFA Institute.

CAPM: Past, Present, And Future Financial Thinking


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