McGraw-Hill

CHAPTER 8
The Law of One Alpha*
A; tke
is one price, there i~ only one rnbpricing.
Arbitrage ensures that there is only one price for a single financial
instrument at any one time. If a share of Apple Computer is trading
at $40 in New York, it can't trade at $45 in Chicago.
But it is estimates of rnispricing that make a market. Investors
have different horizons, different casMow needs, different economic
outlooks, and different approaches to valuation. Their exp
tations for any given stock are likely to differ accordingly.
Should what holds true for investors in general also hold true
for a single investment firm? In particular, for quantitative firms,
where "discipline" connotes a philosophy as well as an investment
approach, does it make sense to have multiple expectations for the
same stock? Yet multiple expectations be may the result when a single
firm applies a variety of models to its investment portfolios.
Consider a firm that manages a "core" portfolio whose selection
universe is coterminous with some broad market index such a
the Russell 1000 and a "value" portfolio whose selection universe
comprises 500 stocks within that broader universe. The firm presumably
has a single expectation (or a single of range expectations)
for each stock in the broad, core universe. Should it have a second
set of expectations for the 500 stocks that form the value subset of
that universe?
* Originally published in the Jouml ofPortfolio Managemoll 21 (4): 7M9.
247