Risk-Return Analysis, Volume 2: The Theory and Practice of Rational Investing

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THE PORTFOLIO SELECTION CONTEXT

INTRODUCTION

The four volumes of this book are concerned with the theory and practice of rational investing and, in particular, how risk-return analysis can help human decision makers (HDMs) approximate such investing. As in Volume I of this book, and in Markowitz (1959), we postulate rational decision makers (RDMs) who are like HDMs in their institutions, motivations, and limited information, but who differ from HDMs in having faultless logic, unlimited instantaneous computing capacity and, as we saw in Chapter 1, the ability to accurately perceive their own preferences.

We view the RDM as a platonic ideal that we seek to emulate. The basic assumption of such an approach is that if we do it right, such ...