William F. Sharpe's Contributions to Financial Economics

Abstract

William Sharpe's published work on the capital asset pricing model (CAPM) and his related work on portfolio theory and portfolio performance measurement have had and continue to have enormous impact on scholarly research in financial economics. However, the impact of this pathbreaking research goes far beyond the academic community by ultimately improving, through numerous applications to practical problems in both investments and financial management, the allocative efficiency of capital markets. These applications range from the riskadjusted performance measurement for mutual funds (sometimes called unit trusts) and pension funds, to the determination of prices for regulated natural monopolies such as electric and telephone utilities. His empirical work on mutual fund performance and the subsequent research that it inspired have led to the establishment of passively managed index funds with enormous savings in transaction costs to pension fund participants and investors in mutual funds. Other major contributions to financial economics by Sharpe include: (i) the binomial pricing model, which provided an efficient method for determining the values of complicated American options; and (ii) his rigorous analysis of the incorrect incentives created by constant cost deposit insurance, which predicted the subsequent debacle in the U.S. thrift industry.