Who Is Harry Markowitz?
Harry Markowitz (1927- ) is a Nobel Prize winning economist who devised the modern portfolio theory, introduced to academic circles in his article, "Portfolio Selection," which appeared in the Journal of Finance in 1952. Markowitz's theories emphasized the importance of portfolios, risk, the correlations between securities, and diversification. His work, in collaboration with Merton H. Miller and William F. Sharpe, changed the way that people invested. These three intellectuals shared the 1990 Nobel Prize in Economics. Markowitz is currently a professor at the Rady School of Management of the University of California at San Diego.
Harry Markowitz Explained
In his own words, Harry Markowitz said, "the basic concepts of portfolio theory came to me one afternoon in the library while reading John Burr Williams's Theory of Investment Value. Williams proposed that the value of a stock should equal the present value of its future dividends. Since future dividends are uncertain, I interpreted Williams's proposal to be to value a stock by its expected dividends. But if the investor were only interested in expected values of securities, he or she would only be interested in the expected value of the portfolio; and to maximize the expected value of a portfolio one need invest only in a single security."
Investing in a "single security" did not make sense to Markowitz. Thus, Markowitz embarked on developing the modern portfolio theory with the foundation of diversification underpinned by concepts of risk, return, variance, and covariance. Markowitz explains: "Since there were two criteria, risk and return, it was natural to assume that investors selected from the set of Pareto optimal risk-return combinations." Known as the Markowitz efficient set, the optimal risk-return combination of a portfolio lies on an efficient frontier of maximum returns for a given level of risk based on mean-variance portfolio construction. The theory of mean-variance portfolios that Markowitz revolutionized eventually extended to the development of capital asset pricing model, a vital component of investment management practice.