On a "vacation" to Colorado, Treynor spent three weeks producing 44 pages of mathematical notes regarding the formulas behind choosing an appropriate discount rate. ADL gave Treynor permission to spend time at MIT, working under the direct supervision of Franco Modigliani where he laid the framework for what would be known as the capital asset pricing model, stating that an asset's price depends on its level of systematic risk.
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A for Bubba.
ReplyDeleteThis is huge: a major question in every student's first finance class is where the discount rate comes from. In the mid-50's, Treynor wouldn't let this question rest. He produced a paper while working at ADL that was circulated to Lintner, Miller and Modigliani (the latter two got Nobel prizes). Further, it was an improvement Tobin's work, for which he won a Nobel too. This isn't bad company.
Treynor's theory isn't fully fleshed out. But the quote at the end of the section about covariances is critical: if you check that against the formula for a slope coefficient from a textbook on regression, it is identical.