Foundations of Portfolio Theory

Prize Lecture to the memory of Alfred Nobel, December 7, 1990.Portfolio Theory;

Searching for the Kuhnian moment : the Black-Scholes-Merton formula and the evolution of modern finance theory

The Black-Scholes-Merton formula has been put to widespread use by options traders because it provides a means of calculating the theoretically 'correct' price of stock options. Traders can therefore see whether the market price of stock options undervalues or overvalues them compared with their hypothetical Black-Scholes-Merton price, before choosing to buy or sell options accordingly. As a consequence of this close relationship between options pricing theory and options pricing practice, a strong performativity loop was activated, whereby market prices quickly converged on the hypothetical Black-Scholes-Merton prices following the dissemination of the formula. The theory has therefore had significant real-world effects, but how should we characterize the initial instinct to derive the theory from a philosophy of science perspective? The two books under review suggest that a Kuhnian reading of the advancement of scientific knowledge might well be the most appropriate. But, on closer inspection, it becomes clear that the publication of the Black-Scholes-Merton formula should not be seen as a Kuhnian moment with paradigm-shaping attributes. It is shown that, at most, the formula acts as an important exemplar which, via its use in the training of options pricing theorists and options pricing practitioners, reinforces the entrenchment of finance theory within the orthodox economics worldview

A Cryogenic Silicon Interferometer for Gravitational-wave Detection

The detection of gravitational waves from compact binary mergers by LIGO has opened the era of gravitational wave astronomy, revealing a previously hidden side of the cosmos. To maximize the reach of the existing LIGO observatory facilities, we have designed a new instrument that will have 5 times the range of Advanced LIGO, or greater than 100 times the event rate. Observations with this new instrument will make possible dramatic steps toward understanding the physics of the nearby universe, as well as observing the universe out to cosmological distances by the detection of binary black hole coalescences. This article presents the instrument design and a quantitative analysis of the anticipated noise floor

Risk and Lack of Diversification under Employee Ownership and Shared Capitalism

Some analysts view risk as the Achilles Heel of employee ownership and to some extent variable pay plans such as profit sharing and gainsharing. Workers in such "shared capitalist" firms may invest too much of their wealth in the firm, contrary to the principle of diversification. This paper addresses whether the risk in shared capitalism makes it unwise for most workers or whether the risk can be managed to limit much of the loss of utility from holding the extra risk. We create an index of financial security based on worker pay and wealth, and find that workers who feel financially insecure exhibit fewer of the positive outcomes associated with shared capitalism, and are less interested than other workers in receiving more employee ownership or even more profit sharing in their workplaces. This response is substantially lessened, however, when accounting for worker empowerment, good employee relations, and high-performance work bundles that appear to buffer worker response toward risk and increase interest in shared capitalism plans. We also discuss portfolio theory which suggests that any risky investment -- including stock in one's company -- can be part of an efficient portfolio as long as the overall portfolio is properly diversified. We show that given estimates of risk aversion parameters, workers could prudently hold reasonable proportions of their assets in employee stock ownership of their firm with only a modest loss in utility due to risk. A good strategy for firms is to personalize individual portfolios on the basis of worker characteristics and preferences, developing investment strategies that would diversify each worker's entire portfolio in ways consistent with individual risk preferences.

Searching for a Stochastic Background of Gravitational Waves with LIGO

The Laser Interferometer Gravitational-wave Observatory (LIGO) has performed the fourth science run, S4, with significantly improved interferometer sensitivities with respect to previous runs. Using data acquired during this science run, we place a limit on the amplitude of a stochastic background of gravitational waves. For a frequency independent spectrum, the new limit is $\Omega_{\rm GW} < 6.5 \times 10^{-5}$. This is currently the most sensitive result in the frequency range 51-150 Hz, with a factor of 13 improvement over the previous LIGO result. We discuss complementarity of the new result with other constraints on a stochastic background of gravitational waves, and we investigate implications of the new result for different models of this background.Comment: 37 pages, 16 figure

All-sky search for periodic gravitational waves in LIGO S4 data

We report on an all-sky search with the LIGO detectors for periodic gravitational waves in the frequency range 50-1000 Hz and with the frequency's time derivative in the range -1.0E-8 Hz/s to zero. Data from the fourth LIGO science run (S4) have been used in this search. Three different semi-coherent methods of transforming and summing strain power from Short Fourier Transforms (SFTs) of the calibrated data have been used. The first, known as "StackSlide", averages normalized power from each SFT. A "weighted Hough" scheme is also developed and used, and which also allows for a multi-interferometer search. The third method, known as "PowerFlux", is a variant of the StackSlide method in which the power is weighted before summing. In both the weighted Hough and PowerFlux methods, the weights are chosen according to the noise and detector antenna-pattern to maximize the signal-to-noise ratio. The respective advantages and disadvantages of these methods are discussed. Observing no evidence of periodic gravitational radiation, we report upper limits; we interpret these as limits on this radiation from isolated rotating neutron stars. The best population-based upper limit with 95% confidence on the gravitational-wave strain amplitude, found for simulated sources distributed isotropically across the sky and with isotropically distributed spin-axes, is 4.28E-24 (near 140 Hz). Strict upper limits are also obtained for small patches on the sky for best-case and worst-case inclinations of the spin axes.Comment: 39 pages, 41 figures An error was found in the computation of the C parameter defined in equation 44 which led to its overestimate by 2^(1/4). The correct values for the multi-interferometer, H1 and L1 analyses are 9.2, 9.7, and 9.3, respectively. Figure 32 has been updated accordingly. None of the upper limits presented in the paper were affecte

Search for gravitational waves from binary inspirals in S3 and S4 LIGO data

We report on a search for gravitational waves from the coalescence of compact binaries during the third and fourth LIGO science runs. The search focused on gravitational waves generated during the inspiral phase of the binary evolution. In our analysis, we considered three categories of compact binary systems, ordered by mass: (i) primordial black hole binaries with masses in the range 0.35 M(sun) < m1, m2 < 1.0 M(sun), (ii) binary neutron stars with masses in the range 1.0 M(sun) < m1, m2 < 3.0 M(sun), and (iii) binary black holes with masses in the range 3.0 M(sun)< m1, m2 < m_(max) with the additional constraint m1+ m2 < m_(max), where m_(max) was set to 40.0 M(sun) and 80.0 M(sun) in the third and fourth science runs, respectively. Although the detectors could probe to distances as far as tens of Mpc, no gravitational-wave signals were identified in the 1364 hours of data we analyzed. Assuming a binary population with a Gaussian distribution around 0.75-0.75 M(sun), 1.4-1.4 M(sun), and 5.0-5.0 M(sun), we derived 90%-confidence upper limit rates of 4.9 yr^(-1) L10^(-1) for primordial black hole binaries, 1.2 yr^(-1) L10^(-1) for binary neutron stars, and 0.5 yr^(-1) L10^(-1) for stellar mass binary black holes, where L10 is 10^(10) times the blue light luminosity of the Sun.Comment: 12 pages, 11 figure

Search for Gravitational Wave Bursts from Soft Gamma Repeaters

We present the results of a LIGO search for short-duration gravitational waves (GWs) associated with Soft Gamma Repeater (SGR) bursts. This is the first search sensitive to neutron star f-modes, usually considered the most efficient GW emitting modes. We find no evidence of GWs associated with any SGR burst in a sample consisting of the 27 Dec. 2004 giant flare from SGR 1806-20 and 190 lesser events from SGR 1806-20 and SGR 1900+14 which occurred during the first year of LIGO's fifth science run. GW strain upper limits and model-dependent GW emission energy upper limits are estimated for individual bursts using a variety of simulated waveforms. The unprecedented sensitivity of the detectors allows us to set the most stringent limits on transient GW amplitudes published to date. We find upper limit estimates on the model-dependent isotropic GW emission energies (at a nominal distance of 10 kpc) between 3x10^45 and 9x10^52 erg depending on waveform type, detector antenna factors and noise characteristics at the time of the burst. These upper limits are within the theoretically predicted range of some SGR models.Comment: 6 pages, 1 Postscript figur