Knowledge that Transforms

In this article, the quantitative form of capital market equilibrium is derived for a multi-period economy in which (a) there are many consumption goods whose future prices are uncertain, and (b) the investment opportunities available to consumers include both common stocks and default-free bills of many different maturities. Particular emphasis is placed on consumer reaction to uncertainty about shifts in commodity prices and the term structure of interest rates and on the way one should expect to observe this reaction reflected in portfolio choices and equilibrium stock prices.

The purpose of this paper is to note that the question of optimal diversification cannot be answered simply by determining the average variability of equally allocated investment. Empirical results are presented which show that it is possible to obtain the same level of average variation with far greater average portfolio returns and fewer securities in the portfolio by using an alternative allocation scheme.