- Person
- Harry Markowitz
- Lived
- 1927–2023
- Field
- Financial economics
- From
- American
The story
In his 1952 paper "Portfolio Selection", Harry Markowitz showed that investors should choose portfolios by balancing expected return against risk, measured by the variance of returns. Because a portfolio's risk depends on how every pair of assets moves together, he faced a practical problem: how to calculate the best combinations when there are many possible assets to choose from.
In 1952 he joined the RAND Corporation, and shortly afterwards George Dantzig, the inventor of the simplex method of optimisation, joined too. Markowitz later wrote that the techniques he learned from Dantzig, beyond the basic simplex method he had already studied on his own, were clearly reflected in his work on the fast computation of what he called mean-variance frontiers. He developed the critical line algorithm, which identifies the optimal mean-variance portfolios, and published it in 1956. He set it out again in an appendix to his 1959 book.
The Nobel committee explained that in his 1956 essay Markowitz showed how the problem of actually calculating the optimal portfolio could be solved. In technical terms it is a quadratic programming problem, built from the expected returns of the assets, their variances and covariances, and the investor's budget. The committee noted that the model won wide acclaim for its algebraic simplicity and its suitability for practical use.
The result is known as the Markowitz efficient frontier: the set of portfolios that give the highest expected return for each level of risk. When every possible portfolio is plotted on a chart of risk against return, the frontier forms the upper edge of the region, part of a curve sometimes called the Markowitz bullet. A portfolio on the frontier is one where further diversification cannot lower risk without reducing expected return, so an investor need only consider portfolios on that line.
These ideas of efficiency were essential to what came next. In the 1960s William Sharpe and others built on Markowitz's portfolio theory to develop the Capital Asset Pricing Model, a theory of how the prices of financial assets are formed. Sharpe shared the 1990 Nobel Prize with Markowitz and Merton Miller.
Why it matters
The efficient frontier turned portfolio theory into a practical tool that investment managers could actually compute and use.
About Harry Markowitz
Chicago grocer’s son whose 1952 paper ‘Portfolio Selection’ founded modern portfolio theory, the mathematics of diversification behind how the world invests. Nobel 1990.
More about Harry Markowitz
- Harry Markowitz developed buddy memory allocationHarry Markowitz developed the buddy memory allocation method, included in the first version of his SIMSCRIPT language, a technique for managing computer memory.
- Harry Markowitz created the SIMSCRIPT simulation languageIn the early 1960s Harry Markowitz returned to RAND to develop SIMSCRIPT, a programming language that made computer simulations much faster to build.
- Harry Markowitz pioneered sparse matrix computingAt RAND in the 1950s Harry Markowitz saw that big economic models were mostly zeros, and devised sparse matrix techniques now standard for solving huge systems of equations.
- Harry Markowitz wrote the book on efficient diversificationHarry Markowitz’s 1959 book Portfolio Selection: Efficient Diversification of Investments, written at Yale’s Cowles Foundation, set out his theory in full.
- Harry Markowitz turned diversification into a scienceIn his 1952 paper “Portfolio Selection”, Harry Markowitz showed mathematically how investors can reduce risk through diversification, founding modern portfolio theory.
Sources
- Harry Markowitz Wikipedia
- Harry M. Markowitz: Biographical NobelPrize.org
- Harry Markowitz Jewish Virtual Library
- Press release: The Prize in Economic Sciences 1990 NobelPrize.org
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