Jack L. Treynor

TL;DR: In this paper, the authors explore the link between conventional subjective, judgmental, work of the security analyst and the essentially objective, statistical approach to portfolio selection of Markowitz and his successors.

Abstract: by Craig William French This paper reprints an edited version of Jack Treynor's famous 1962 manuscript. The author's facsimile of the original mimeograph was obtained thanks to the kind generosity of Professor Elroy Dimson of the London Business School. Edits in the present version, which differ from the original Rough Draft, include minor typographical corrections and minor notation differences for some variables in the formulae. Specifically, where Mr. Treynor used a bar or curve over a variable, I use an underscore, and I have omitted the upper and lower limits (and their index) above and below all Sigma summation signs as the nature of the summations is clear. Pagination is as in the original. I have otherwise attempted, in this replica, to preserve the vintage character of the document, including font style, spacing, margins and a reproduction reminiscent of the days prior to the invention of photocopy machines and modern portfolio theory. Unfortunately, I could not replicate the wonderful mimeo aroma. Mr. Treynor points out that many minor changes will be evident to anyone who compares the Craig French version to the version in Robert Korajczyk's book, Asset Pricing and Portfolio Performance, Risk Books, London, 1999 [Chapter 2, pp. 15-22]. Mr. Treynor considers all French's changes improvements. A more complete description of the development of the Treynor CAPM may be found in French, Craig W., “The Treynor Capital Asset Pricing Model”. Journal of Investment Management, Vol. 1, No. 2, pp. 6072, 2003. Available at SSRN: http://ssrn.com/abstract=447580. ROUGH DRAFT TOWARD A THEORY OF MARKET VALUE OF RISKY ASSETS The objective of this paper is to lay the groundwork for a theory of market value which incorporates risk. We consider a highly idealized model of a capital market in which it is relatively easy to see how risk premiums implicit in present share prices are related to the portfolio decisions of individual investors. In a real market institutional complexities, frictions, taxes, and certain other complications which are absent in our model may have a significant effect on share prices. The aim of the paper, however, is not to present a fully developed apparatus for computing the cost of capital in practical problems. The present aim is merely: 1. to show that, under our assumptions, optimal portfolio – balancing behavior by the individual investor leads to Proposition I of the famous Modigliani-Miller paper; 2. to explore the manner in which risk affects investment value; 3. to introduce the concept of insurability. Insurable risks have a negligible effect on the cost of capital. We will develop a mathematical definition of insurability based on the assumptions of our market model, according to which whether a risk is insurable or uninsurable is a matter of degree; nevertheless, we shall argue that it is often useful to treat risk as falling cleanly into one class or the other.

TL;DR: A slightly edited version of Treynor's 1961 CAPM manuscript has been published by French et al. as discussed by the authors, with minor typographical corrections and minor notation differences for some variables in the formulae.