Who is Harry Markowitz?
Harry Markowitz (1927-) is a Nobel Prize winning economist who developed modern portfolio theory, presented to academia in his article, “Portfolio Selection”, published in the Journal of Finance in 1952. Markowitz’s theories emphasized the importance of portfolios, risk, correlations between securities and diversification. His work, in collaboration with Merton H. Miller and William F. Sharpe, has changed the way people invest. These three intellectuals shared the 1990 Nobel Prize in economics. Markowitz is currently a professor at the Rady School of Management at the University of California at San Diego.
Harry Markowitz explained
In his own words, said Harry Markowitz, “the basic concepts of portfolio theory came to me one afternoon in the library when reading John Burr Williams Investment value theory. Williams proposed that the value of a share be equal to the present value of its future dividends. Since future dividends are uncertain, I interpreted Williams’ proposal to be to value a stock by its expected dividends. But if the investor was only interested in the expected value of the securities, he would only be interested in the expected value of the portfolio; and to maximize the expected value of a portfolio, just invest in one security. “
Investing in “unique security” made no sense to Markowitz. Thus, Markowitz embarked on the development of modern portfolio theory with the foundations of diversification underpinned by the concepts of risk, return, variance and covariance. Markowitz explains: “Since there were two criteria, risk and return, it was natural to assume that the investors selected from the set of optimal risk-return combinations of Pareto.” Known as the Markowitz effective set, the optimal risk-return combination for a portfolio is based on an efficient frontier of maximum returns for a given level of risk depending on the construction of the medium variance portfolio. The theory of medium variance portfolios that Markowitz revolutionized eventually spread to the development of a fixed asset pricing model, a vital component of investment management practices.