SKILL IN SELECTING PARTICULAR ASSETS

SKILL IN SELECTING PARTICULAR ASSETS

SKILL IN SELECTING PARTICULAR ASSETS

SKILL IN SELECTING PARTICULAR ASSETS

An investor's skill in selecting assets of a particular class, say, common stocks, is properly judged by comparing the rate of return onthese assets with other assets of the same degree of riskiness. For portfolios of common stocks having a small degree of risk or the samedegree of risk as the market as a whole, the bench mark is easilydenned. There are some details that need to be taken care of, butthey are not difficult.

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The market portfolio which is used in defining Sharpe's capitalmarket line includes all common stocks with the value of each beingproportional to its market value. If the bench mark is to be the capital market line, and it is a good one, either the New York Stock Exchange Composite Index or the Standard & Poor's "500" is a reasonable first approximation.Each is a value-weighted index of prices of stocks on the New York Stock Exchange. Although the Standard& Poor's Composite Index does not include all stocks, the market value of the included stocks is about 80 percent of the total value of all common stocks. As a consequence, the movements in the Standard & Poor'sIndex are highly correlated with movements in the New York StockExchange Composite Index, and the correlation coefficient between the two indexes is close to 1.0. For example, for the period January1939 to December 1966, the correlation between closing values ofthe two indexes on the last Friday of the month is 0.913. The estimatedregression coefficient is 0.865.

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The reason for calling these indexes only first approximations is thatthe universe of stocks available for investments is far more extensivethan those listed on the New York Stock Exchange. About 1,200 stocksare listed on the American Stock Exchange and there are more than10,000 reasonably actively traded stocks in the over-the-counter market. Although the number of stocks not listed on the New YorkStock Exchange vastly exceeds the number so listed, the market valueof stocks on the New York Stock Exchange at the end of 1970 was about 70 percent of the total value of publicly traded stocks in theUnited States.

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