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Efficiently Inefficient

Efficiently Inefficient describes the key trading strategies used by hedge funds and demystifies the secret world of active investing. Leading financial economist Lasse Heje Pedersen combines the latest research with real-world examples and interviews with top hedge fund managers to show how certain trading strategies make money--and why they sometimes don't. Pedersen views markets as neither perfectly efficient nor completely inefficient. Rather, they are inefficient enough that money managers can be compensated for their costs through the profits of their trading strategies and efficient enough that the profits after costs do not encourage additional active investing. Understanding how to trade in this efficiently inefficient market provides a new, engaging way to learn finance. Pedersen analyzes how the market price of stocks and bonds can differ from the model price, leading to new perspectives on the relationship between trading results and finance theory. He explores several different areas in depth--fundamental tools for investment management, equity strategies, macro strategies, and arbitrage strategies--and he looks at such diverse topics as portfolio choice, risk management, equity valuation, and yield curve logic. The book's strategies are illuminated further by interviews with leading hedge fund managers: Lee Ainslie, Cliff Asness, Jim Chanos, Ken Griffin, David Harding, John Paulson, Myron Scholes, and George Soros. Efficiently Inefficient effectively demonstrates how financial markets really work. Free problem sets are available online at
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Table of Contents

The Main Themes in Three Simple Tables vii Preface xi Who Should Read the Book? xiv Acknowledgments xv About the Author xvii Introduction 1 i. Efficiently Inefficient Markets 3 ii. Global Trading Strategies: Overview of the Book 7 iii. Investment Styles and Factor Investing 14 Part I Active Investment 17 Chapter 1 Understanding Hedge Funds and Other Smart Money 19 Chapter 2 Evaluating Trading Strategies: Performance Measures 27 Chapter 3 Finding and Backtesting Strategies: Profiting in Efficiently Inefficient Markets 39 Chapter 4 Portfolio Construction and Risk Management 54 Chapter 5 Trading and Financing a Strategy: Market and Funding Liquidity 63 Part II Equity Strategies 85 Chapter 6 Introduction to Equity Valuation and Investing 87 Chapter 7 Discretionary Equity Investing 95 Interview with Lee S. Ainslie III of Maverick Capital 108 Chapter 8 Dedicated Short Bias 115 Interview with James Chanos of Kynikos Associates 127 Chapter 9 Quantitative Equity Investing 133 Interview with Cliff Asness of AQR Capital Management 158 Part III Asset Allocation and Macro Strategies 165 Chapter 10 Introduction to Asset Allocation: The Returns to the Major Asset Classes 167 Chapter 11 Global Macro Investing 184 Interview with George Soros of Soros Fund Management 204 Chapter 12 Managed Futures: Trend-Following Investing 208 Interview with David Harding of Winton Capital Management 225 Part IV Arbitrage Strategies 231 Chapter 13 Introduction to Arbitrage Pricing and Trading 233 Chapter 14 Fixed-Income Arbitrage 241 Interview with Nobel Laureate Myron Scholes 262 Chapter 15 Convertible Bond Arbitrage 269 Interview with Ken Griffin of Citadel 286 Chapter 16 Event-Driven Investments 291 Interview with John A. Paulson of Paulson & Co. 313 References 323 Index 331

About the Author

Lasse Heje Pedersen is a finance professor at Copenhagen Business School and New York University's Stern School of Business, and a principal at AQR Capital Management. A distinguished financial economist, he has won a number of awards, notably the Bernacer Prize, awarded to European economists under forty who have made outstanding contributions in macroeconomics and finance.


"Pedersen's book can be recommended to a wide spectrum of readers interested in financial markets in general and hedge funds in particular."--Jacek Klich, Central Banking "Encyclopedic in its cataloguing of active management strategies and authoritative in its analysis of the practical issues of their implementation. Pedersen grounds his exposition in landmark scholarly articles and, where quantitative analysis is required to elucidate a concept, conveys his message without resorting to arcane mathematics."--Martin S. Fridson, Financial Analysts Journal "Despite the author's high level of understanding he manages to deliver a high quality but also easily understandable guide to the strategies."--Mats Larsson, Investing by the Books

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