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Markowitz (1952)
Markowitz (1952)
Portfolio Selection
Author(s): Harry Markowitz
Source: The Journal of Finance, Vol. 7, No. 1 (Mar., 1952), pp. 77-91
Published by: Wiley for the American Finance Association
Stable URL: http://www.jstor.org/stable/2975974 .
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= XiEdit rit)
i=l t=l
V is theaveragesquareddeviationof Y fromitsexpectedvalue. V is a
commonly used measureof dispersion.Othermeasuresof dispersion,
closelyrelatedto V are the standarddeviation,o-= -VV and theco-
ofvariation,alE.
efficient
Suppose we have a numberof randomvariables: R1, . . . , R,. If R is
a weightedsum (linearcombination) oftheRi
aLiRi+ a2R2+. . . + a.R.
V (R) = aiajxij
R-=RiXi
E = 1
and thevarianceis
V= oEijxix
i-1 j-1
/ a~~~~~ffa;'nable
E,V combinations
\ / ~~~~~~~~~~~~~fficient
\ /"~ E,V combinations
E
FIG. 1
1) E =EXil4
3 3
2) V =iXjaij
i=l j=l
3
3) EXi=1
i-1
Thus theslopeoftheisomeanlineassociatedwithE = Eo is - (1 -
A3)/(2 - A3) its interceptis (E0 - A3)/(Ab2 - 3). If we changeE we
changetheintercept but not the slopeof theisomeanline.This con-
firmsthe contention theisomeanlinesforma systemofparallel
that
lines.
Similarly,by a somewhatless simpleapplicationofanalyticgeome-
try,we can confirm the contention thatthe isovariancelinesforma
family of concentricellipses. The "center" of the systemis thepoint
which minimizes V. We will label this pointX. Its expectedreturnand
variancewe willlabel E and V. Varianceincreasesas you moveaway
fromX. Moreprecisely, if one isovariancecurve,C1,lies closerto X
thananother,C2,thenC1is associatedwitha smallervariancethanC2.
Withthe aid of the foregoing geometric apparatuslet us seek the
efficientsets.
X, the centerof the systemof isovarianceellipses,may falleither
insideoroutsidetheattainableset.Figure4 illustrates a case in which
X fallsinsidetheattainableset.In thiscase: Xis efficient. Forno other
has as
portfolio a V low X; as therefore no portfolio have either
can
smallerV (withthesameor greaterE) or greaterE withthesameor
smallerV. No point (portfolio) withexpectedreturnE less than E
For we have E > E and V < V.
is efficient.
Considerall pointswitha givenexpectedreturn E; i.e.,all pointson
theisomeanlineassociatedwithE. The point theisomeanlineat
of
whichV takeson itsleastvalue thepointat whichtheisomeanline
is
9. The isomean "Ccurves"are as describedabove except when I,u = ,U2= IA3. In the
lattercase all portfolioshave the same expectedreturnand the investorchooses the one
with minimumvariance.
As to the assumptionsimplicitin our descriptionof the isovariancecurvessee footnote
12.
X2 \ Direction of
increasingE*
\\ \ \ isomean lines--
\\ attainableset
c b
ft~~~ _\\
c \b
\ X
XI
\ \\ \
of increasingE
*direction
depends on It,i,u. #3
FIG. 2
-.0 ~ ~ ~ -
I--,
FIG. 3
Xw|efficient portfolios
FIG. 4
/ I bI _X
set of
efficient
a portfolios
X2
FIG. S
efficient
E,V combinations
E
FIG. 6
X2
a
X ;~~~~~~~~~sovarionee
c b
XI
FIG. 7
theprobabilitydistributionofreturnsfromtheportfoliomay be con-
nectedwitha propensity to gamble.For exampleiftheinvestormaxi-
mizesutility(U) whichdependson E and V(U = U(E, V), d U/1E >
0, d Ul/E < 0) he willneveracceptan actuariallyfair'4bet. But if
13. If R is a randomvariablethattakeson a finite
number ofvaluesrl,. . . , r. with
n
Pi,..., pnrespectively,
probabilities andexpectedvalueE, thenMs = pi(ri-E)3
t=1
14. Oneinwhichtheamount
gainedbywinning
thebettimestheprobability
ofwinning