Modern finance is the body of knowledge built on the pillars of the arbitrage principles of Miller and Modigliani, the portfolio principles of Markowitz, the capital asset pricing theory of Sharpe, Lintner, and Black, and the option-pricing theory of Black, Scholes, and Merton.

Modern finance is also based upon Fama’s Efficient Market Hypothesis, which is both the most regarded and the most criticized of the principles. Modern finance is compelling because it uses a minimum number of tools to build a unified theory intended to answer all the questions of finance.

However, few theories are consistent with all the empirical evidence, and modern finance is no exception. The Efficient Market Hypothesis (EMH) is based on a simple assumption that risk is defined by volatility. Ac­cording to the theory, investors are risk adverse: they will accept lower returns for a less volatile investment, but are willing to accept more risk for higher payoffs. The theory is simple and elegant, and leads into ingenious mathematical proofs and equations, which may be why it has become so widely accepted (Morien, 2005, p. 1).

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