August 24, 1927 (age 85) Chicago, Illinois, USA United States Harry Markowitz Company Rady School of Management at the University of California at San Diego Baruch College of the City University of New York RAND Corporation Cowles Commission



Field Alma mater Opposed

Financial economics University of Chicago, (PhD) John Burr Williams

noting that it had also been a favorite interest of Alfred Cowles. Jacob Marschak. This insight led to the development of his seminal theory of portfolio allocation under uncertainty. in particular the ideas of David Hume. . including Milton Friedman. Markowitz realized that the theory lacks an analysis of the impact of risk. Tjalling Koopmans. While still a student. which at the time consisted in the present value model of John Burr Williams. Jacob Marschak and Leonard Savage.Influences Milton Friedman Tjalling Koopmans Jacob Marschak Leonard Savage Modern Portfolio Theory Efficient/ Markowitz Frontier Contributions Sparse Matrix Methods SIMSCRIPT John von Neumann Theory Prize (1989) The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (1990) Information at IDEAS/RePEc Awards Introduction Harry Markowitz was born on August 24. he was invited to become a member of the Cowles Commission for Research in Economics. There he had the opportunity to study under important economists..A. to his Jewish parents Morris and Mildred Markowitz. an interest he continued to follow during his undergraduate years at the University of Chicago. choosing to specialize in economics. which was in Chicago at the time. published in 1952 by the Journal of Finance. While researching the then current understanding of stock prices. Markowitz chose to apply mathematics to the analysis of the stock market as the topic for his dissertation. Markowitz developed an interest in physics and philosophy. After receiving his B.[1] During high school. 1927 in Chicago. Markowitz decided to continue his studies at the University of Chicago. encouraged him to pursue the topic. the founder of the Cowles Commission. who was the thesis advisor.

sparse matrix methods. Markowitz won the Nobel Memorial Prize in Economic Sciences in 1990 while a professor of finance at Baruch College of the City University of New York. Inc. while Markowitz was defending his dissertation. Harry Markowitz went to work for the RAND Corporation. Milton Friedman argued his contribution was not economics.[3] During 1955–1956 Markowitz spent a year at the Cowles Foundation. The topic was so novel that. further developing the critical line algorithm for the identification of the optimal mean-variance portfolios. video casting lectures. an alternative investment advisory firm and fund of hedge funds. A year later. which had moved to Yale University. where he met George Dantzig. ("Loring Ward"). Markowitz left the company. SIMSCRIPT (I) included the Buddy memory allocation method. a San Jose. In 1955. In the preceding year. Research Affiliates. Markowitz now divides his time between teaching (he is an adjunct professor at the Rady School of Management at the University of California at San Diego. SIMSCRIPT has been widely used to program computer simulations of manufacturing. and as an advisor to the Investment Committee of 1st Global. and consulting (out of his Harry Markowitz Company offices). They helped develop SIMSCRIPT. With Dantzig's help. a 401(k) managed accounts provider and investment advisor. He published the critical line algorithm in a 1956 paper and used this time at the foundation to write a book on portfolio allocation which was published in 1959. 1962 as California Analysis Center. The company that would become CACI International was founded by Herb Karr and Harry Markowitz on July 17. After a successful run as a private hedge fund. relying on what was later named the Markowitz frontier. AMC was sold to Stuart & Co.In 1952. and simulation language programming (SIMSCRIPT). a Dallas. in 1971. Markowitz is co-founder and Chief Architect of GuidedChoice. Sparse matrix methods are now widely used to solve very large systems of simultaneous equations whose coefficients are mostly zero. UCSD). California based investment management firm. Markowitz’s more recent work has included designing the . at the invitation of James Tobin. California-based investment advisor. at RAND and after it was released to the public domain. Arnott's Newport Beach. he received the John von Neumann Theory Prize from the Operations Research Society of America (now Institute for Operations Research and the Management Sciences. the first simulation programming language. He currently serves on the Advisory Board of SkyView Investment Advisors. Markowitz continued to research optimization techniques. Index Funds Advisors. Texas-based wealth management and investment advisory firm. He took over as chief executive in 1970. transportation. In 1968. Markowitz joined Arbitrage Management company founded by Michael Goodkin. he received a PhD from the University of Chicago with a thesis on the portfolio theory. and computer systems as well as war games. CACI was founded to provide support and training for SIMSCRIPT. California and internet based investment advisory firm. which was also developed by Markowitz. on the Advisory Board of Mark Hebner's Irvine. Markowitz also serves on the Investment Committee of LWI Financial Inc. Working with Paul Samuelson and Robert Merton he created a hedge fund that represents the first known attempt at computerized arbitrage trading. INFORMS) for his contributions in the theory of three fields: portfolio theory. on the advisory panel of Robert D.

Harry Markowitz made the following assumption while developing the HM model. Harry Markowitz Model Introduction Harry Markowitz put forward this model in 1952. 4. These concepts of efficiency were essential to the development of the Capital Asset Pricing Model. which were : 1. An investor either maximizes his portfolio return for a given level of risk or maximum return for minimum risk. An investor is risk averse. 6. Markowitz also co-edited the textbook The Theory and Practice of Investment Management with Frank J. the HM model shows investors how to reduce their risk. By choosing securities that do not 'move' exactly together. The Markowitz Efficient Frontier is the set of all portfolios that will give the highest expected return for each given level of risk. 3. An investor is rational in nature. Analysis is based on single period model of investment. each with different return and risk. It assists in the selection of the most efficient by analyzing various possible portfolios of the given securities. two separate decisions are to be made : . Risk of a portfolio is based on the variability of returns from the said portfolio. To choose the best portfolio from a number of possible portfolios. 7. An investor prefers to increase consumption. The investor's utility function is concave and increasing. He is actively involved in designing the next step in the retirement process: assisting retirees with wealth distribution through GuidedSpending. Fabozzi of Yale School of Management. no additional expected return can be gained without increasing the risk of the portfolio). 2. Research A Markowitz Efficient Portfolio is one where no added diversification can lower the portfolio's risk for a given return expectation (alternately. due to his risk aversion and consumption preference.backbone software analytics for the GuidedChoice investment solution and heading the GuidedChoice Investment Committee. 5. The HM model is also called Mean-Variance Model due to the fact that it is based on expected returns (mean) and the standard deviation (variance) of the various portfolios.

Selection of best portfolio out of the efficient set. In Figure 1. they would like to have higher return.1. as there is higher risk for a given rate of return. portfolios are selected as follows: (a) From the portfolios that have the same return. All portfolios that lie below the Efficient Frontier are not good enough because the return would be lower for the given risk. compared to T and U. y2. Determining the Efficient Set A portfolio that gives maximum return for a given risk. All portfolios lying on the boundary of PQVW are called Efficient . For example. Figure 1: Risk-Return of Possible Portfolios As the investor is rational. And as he is risk averse. U. an investor will prefer the portfolio with higher rate of return. he wants to have lower risk. the investor will prefer the portfolio with lower risk. The efficient portfolios are the ones that lie on the boundary of PQVW. or minimum risk for given return is an efficient portfolio. T. at risk level x2. Portfolios that lie to the right of the Efficient Frontier would not be good enough. The boundary PQVW is called the Efficient Frontier. Thus. the shaded area PVWP includes all the possible securities an investor can invest in. and (b) From the portfolios that have the same risk level. Determination a set of efficient portfolios. But portfolio S is called the efficient portfolio as it has the highest return. All the portfolios that lie on the boundary of PQVW are efficient portfolios for a given risk level. there are three portfolios S. 2.

An investor might have satisfaction represented by C2. an investor will be indifferent between combinations S1 and S2. which provide the same satisfaction to the investors. An investor who is highly risk averse will hold a portfolio on the lower left hand of the frontier. and an investor who isn’t too risk averse will choose a portfolio on the upper portion of the frontier. Each curve to the left represents higher utility or satisfaction. The Efficient Frontier is the same for all investors. The goal of the investor would be to maximize his satisfaction by moving to a curve that is higher. C2 and C3 are shown. but if his satisfaction/utility increases. . as all investors want maximum return with the lowest possible risk and they are risk averse. Indifference curves C1. he/she then moves to curve C3 Thus. or S5 and S6. Choosing the best Portfolio For selection of the optimal portfolio or the best portfolio. the risk-return preferences are analyzed. Figure 2: Risk-Return Indifference Curves Figure 2 shows the risk-return indifference curve for the investors. at any point of time. Each of the different points on a particular indifference curve shows a different combination of risk and return.Portfolios.

the investor will get highest satisfaction as well as best risk-return combination. isn't the optimal portfolio even though it lies on the same indifference curve as it is outside the efficient frontier. and it is possible to include risk-free securities in a portfolio as well. This is shown in Figure 3. . This has been explained in Figure 4. R is the point where the efficient frontier is tangent to indifference curve C3.Figure 3: The Efficient Portfolio The investor's optimal portfolio is found at the point of tangency of the efficient frontier with the indifference curve. say X. Another investor having other sets of indifference curves might have some different portfolio as his best/optimal portfolio. A portfolio with risk-free securities will enable an investor to achieve a higher level of satisfaction. even though it lies in the portfolio region. This point marks the highest level of satisfaction the investor can obtain. Portfolio Y is also not optimal as it does not lie on the indifference curve. and is also an efficient portfolio. Any other portfolio. With this portfolio. All portfolios so far have been evaluated in terms of risky securities only.

P. The CML is an upward sloping curve. and the risk is the standard deviation of the portfolio. In the market for portfolios that consists of risky and risk-free securities.IRF)σP/σM Where. R1PX is known as the Capital Market Line (CML). All portfolio combinations to the left of P show combinations of risky and risk-free assets. R1PX is drawn so that it is tangent to the efficient frontier. which means that the investor will take higher risk if the return of the portfolio is also higher. The CML equation is : RP = IRF + (RM . Risk premium is the product of the market price of risk and the quantity of risk. and every investor would prefer to attain this portfolio. as government securities have no risk. It consists of all shares and other securities in the capital market. Any point on the line R1PX shows a combination of different proportions of risk-free securities and efficient portfolios. or the return from government securities. the CML represents the equilibrium condition. The portfolio P is the most efficient portfolio. The satisfaction an investor obtains from portfolios on the line R1PX is more than the satisfaction obtained from the portfolio P. additional funds can be borrowed at riskfree rate and a portfolio combination that lies on R1PX can be obtained.Figure 4: The Combination of Risk-Free Securities with the Efficient Frontier and CML R1 is the risk-free return. and all those to the right of P represent purchases of risky assets made with funds borrowed at the risk-free rate. The Capital Market Line says that the return from a portfolio is the riskfree rate plus risk premium. The P portfolio is known as the Market Portfolio and is also the most diversified portfolio. this line represents the risk-return trade off in the capital market. . In the case that an investor has invested all his funds. as it lies on both the CML and Efficient Frontier.

A rational investor will not invest unless he knows he will be compensated for that risk. the investor can choose the .RP = Expected Return of Portfolio RM = Return on the Market Portfolio IRF = Risk-Free rate of interest σM = Standard Deviation of the market portfolio σP = Standard Deviation of portfolio (RM . is the optimum combination of risky investments and the market portfolio. But when risk-free investments are introduced. 3. or the reward for holding risky portfolio instead of risk-free portfolio.IRF) is a measure of the risk premium. in the absence of risk-free investments. Figure 5: CML and Risk-Free Lending and Borrowing Figure 5 shows that an investor will choose a portfolio on the efficient frontier. CML is always upward sloping as the price of risk has to be positive. Therefore. The characteristic features of CML are: 1. σM is the risk of the market portfolio. Only efficient portfolios that consist of risk free investments and the market portfolio P lie on the CML. the slope measures the reward per unit of market risk. Portfolio P.IRF)/σM is the slope of CML.e. 2. (RM . i. At the tangent point.

Demerits of the HM Model 1. Markowitz showed that under certain given conditions. more extensively. but the contribution of each asset to the risk of the aggregate portfolio. covariance of returns and estimates of return for all the securities in a portfolio. There are numerous calculations involved that are complicated because from a given set of securities. the investor will lend a portion at risk-free rate. measured as its variance.. the essential aspect pertaining to the risk of an asset is not the risk of each asset in isolation. The portion beyond P is called Borrowing Portfolio. in his book. On a general level. 3. 2..e. i. Hence.a theory which evolved into a foundation for further research in financial economics. where the investor borrows some funds at risk-free rate to buy more of portfolio P. the risk of the portfolio. This can be done with borrowing or lending at the risk-free rate of interest (IRF) and the purchase of efficient portfolio P. a very large number of portfolio combinations can be made. In this portion. operational theory for portfolio selection under uncertainty . It requires lots of data to be included. The portion from IRF to P.e. is investment in risk-free assets and is called Lending Portfolio. i. The expected return and variance will also have to computed for each securities  The contribution for which Harry Markowitz now receives his award was first published in an essay entitled "Portfolio Selection" (1952). a theory for optimal investment of wealth in assets which differ in regard to their expected return and risk. but also on the pairwise covariances of all assets. The portfolio an investor will choose depends on his preference of risk. will depend not only on the individual variances of the return on different assets. the expected return on the portfolio and its variance. Markowitz's primary contribution consisted of developing a rigorously formulated. the "law of large numbers" is not wholly applicable to the diversification of risks in portfolio choice because the returns on different assets are correlated in . Portfolio Selection: Efficient Diversification (1959). The so-called theory of portfolio selection that was developed in this early work was originally a normative theory for investment managers.portfolio on the CML (which represents the combination of risky and risk-free investments). an investor's portfolio choice can be reduced to balancing two dimensions. An investor must obtain variances of return. of course. Due to the possibility of reducing risk through diversification. and later. However. investment managers and academic economists have long been aware of the necessity of taking returns as well as risk into account: "all the eggs should not be placed in the same basket".

in general. the building blocks are a quadratic utility function. each with varying properties.practice. is reduced to a conceptually simple two-dimensional problem . the variance and covariance of the assets and the investor's budget restrictions. Markowitz also showed how the problem of actually calculating the optimal portfolio could be solved. expected returns on the different assets.known as mean-variance analysis. regardless of how many types of securities are represented in a portfolio. In this way. the complicated and multidimensional problem of portfolio choice with respect to a large number of different assets. Generally speaking.) The model has won wide acclaim due to its algebraic simplicity and suitability for empirical applications. (In technical terms. Thus. . Markowitz's work on portfolio theory may be regarded as having established financial micro analysis as a respectable research area in economic analysis. In an essay in 1956. risk cannot be totally eliminated. this means that the analysis is formulated as a quadratic programming problem.

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