Finding Alpha

Eric Falkenstein, PhD , developed the RiskCalcTM, the world's leading scoring tool for evaluating private firm default risk, while at Moody's Risk Management Services. The celebrated tool is used by banks worldwide, as well as by regulators and Moody's own CDO group. He was head of capital allocations and quantitative modeling at KeyCorp prior to joining Moody's and later was with Deephaven Capital Management where he developed and managed a long/short equity strategy. Between 1996 and 2002, Falkenstein formed his own investment company, the Falken Fund, which had returns of 16.0% versus 3.8% for the S&P500. His hedge fund activities are ongoing and, by law, proprietary. He is a consultant and a member of CapRock Advisors LLC, a hedge fund advisor.

CHAPTER 1 Risk Uncorrelated with Returns. The Response: Return (Risk (Return)). Failed Paradigms. You Minimize Some Risks, Pay to Take Others. CHAPTER 2 The Creation of the Standard Risk-Return Model. The CAPM. Pillar 1: Decreasing Marginal Utility Means Risk Aversion. Pillar 2: Diversification Means Not All Risk Is the Same. The Arbitrage Pricing Theory (APT). The Stochastic Discount Factor (SDF). Adding Non-Normality. The Uncertainty Revival. CAPM: A Special Case of the Stochastic Discount Factor Model. CHAPTER 3 An Empirical Arc. The Beginning of the End of CAPM. APT Tests. Fama and French Put a Fork in the CAPM. Saving the Standard Model. Serial Changes to APT. Skewness. Analogy to Business Cycle Forecasting. Summary. CHAPTER 4 Volatility, Risk, and Returns. Total Volatility and Cross-Sectional Returns. Beta-Sorted Portfolios. Call Options. Small Business. Leverage. Mutual Funds. Futures. Currencies. Lotteries. Movies. World Country Returns. Corporate Bonds. The Long End of the Yield Curve. Distress Risk. Sports Books. Total Volatility and Expected Equity Index Returns. Uncertainty and Returns. IPOs. Trading Volume. Volatility as Shorthand for Risk. CHAPTER 5 Investors Do Not Mind Their Utility Functions. Behavioral Violation 1: Investors Trade Too Much. Behavioral Violation 2: Too Many Funds. Behavioral Violation 3: Underdiversification. Behavioral Violation 4: No Fundamental Analysis. Behavioral Violation 5: Buy Recommendations Exclude Firms with Merely Low Risk. Behavioral Violation 6: Agents Do Not Agree. Behavioral Violation 7: The Home Bias. The Rotten Core: The Utility Function. Absurd Extrapolations. Easterlin's Paradox. Summary. CHAPTER 6 Is The Equity Risk Premium Zero? Geometric versus Arithmetic Averaging. Survivorship Bias. Peso Problems. One-time Effect of an Anomalous Post-Depression Period. Asymmetric Tax Effects. Market Timing. Transaction Costs. Summary. CHAPTER 7 Undiminished Praise of a Vacuous Theory. CHAPTER 8 Why Relative Utility Generates Zero-Risk Premiums. Benchmark Risk. Why Relative Risk Leads to No Risk Premium. CHAPTER 9 Why We Are Inveterate Benchmarkers. Typical Economic Assumptions. Virtue of Selfishness. Why Envy Is Virtuous. Why Economists Dislike Envy in General. CHAPTER 10 Alpha, Risk, and Hope. The Search for Safety. Most Financial Risk Takers Are Foolish. Two Types of Priced Risk. Uncertainty in Innovation. Why Risk Taking Hurts. Confusion of Risk and Gambling. Standard Alpha Contradiction. Why We Take Risk Anyway. Experiments, Risk, and Alpha. CHAPTER 11 Examples of Alpha. Finding the Right Alpha. Arbitraging Put-Call Parity. Convexity Trade in Futures and Swaps. Pairs and Mean Reversion. Fund Innovations. Convertible Bonds. Long and Short Equity Hedge Funds. Automating Activities. Conclusion. CHAPTER 12 Alpha Games. Benign Deception. The Favor Bank. Managerial Alpha. The Alpha in Risk Management. A Singular Risk Management Decision. Risk Management Like Audit. Overpaid Alpha Deceptors. Investor Meets Alpha. CHAPTER 13 Alpha Seeking Applications. Minimum Volatility Portfolio. Beta Arbitrage. Investing in Anomalies. Safety Investing. Hope Investing. Relative Risk and Bubbles. Capital Finding Alpha Strategies. Search for Alpha. CHAPTER 14 Conclusion. Notes. Index.