Advanced Modelling in Finance Using Excel and VBA

Chapter 5. Introduction to Equities

In Part II of the book we look at equities. The coverage of relevant topics is spread over the following three chapters: Chapter 6 on portfolio optimisation, Chapter 7 on asset pricing and Chapter 8 on performance measurement and attribution. In this introductory chapter, we briefly summarise the finance theory covered in the Equities part of the book and introduce the range of numerical methods implemented in the spreadsheets that accompany the text.

The development of mean—variance portfolio theory in the fifties by Harry Markowitz provided the genesis of finance as an academic subject, separate from but related to economics. Markowitz pointed out the crucial distinction between the risk of individual equities and the contribution of an individual equity to portfolio risk. One important feature of mean—variance portfolio theory was the identification of return and risk with mean and variance. By linking the variation in returns to the normal distribution, much classical statistical analysis was available to implement finance theory. Following on from portfolio theory in the sixties came the capital asset pricing model (CAPM), a single-factor model of expected equity returns, introducing beta as an important measure of portfolio risk. In the aftermath of the CAPM various measures of portfolio performance were suggested. Subsequent developments incorporated multiple-factor models for portfolio returns, the latest example of which is Sharpe's style ...