Investment Decision Making

This chapter is a review of different approaches academics take to find right answers on the question how investors' community makes decisions on optimal portfolio of securities and how this process converges toward capital market equilibrium. Authors will try to reconcile the approaches that come from different intellectual traditions. The authors start with the Capital Assets Pricing Model (hereafter CAPM). For decades long the model has been a cornerstone of modern finance literature and a guide for investment decision making. The model assumes that the choice of investment portfolio is directed toward optimization between statistically defined risk and observable return of a universe of available investments, in the setting of rational and homogeneous agents where information is common knowledge. The rigidity of CAPM assumptions led to a plethora of studies where some of those assumptions are relaxed. An important breakthrough to the extant body of knowledge has been made by the introduction of the asymmetric information in the decision-making process.