Harry Markowitz: creator of modern portfolio theory (2023)

Harry Markowitz (born 1927) is a Nobel Prize-winning American economist best known for his engineeringModern portfolio theory(MPT), an innovative investment strategy based on the recognition that the performance of a single stock is not as important as the performance and composition of an investor's overall portfolio.

Ever since Markowitz introduced MPT to academic circles in his article “Portfolio Selection”.The Journal of FinanceIn 1952, his original theory fundamentally changed the way people and institutions invest.

Markowitz received the 1990 Nobel Prize in Economics for his theory of asset allocation under uncertainty, also known as portfolio choice theoryWilliam F. SharpeeMerton Miller. In particular, the Nobel Committee called Markowitz's theory of portfolio choice the "first groundbreaking contribution to the field of financial economics". The Nobel Committee also recognized that Markowitz's original wallet theory was the basis for "a second major contribution to the theory of financial economics": theAsset Pricing Model Capital(CAPM), a theory of financial asset pricing developed by William Sharpe and other researchers in the 1960s.

Main Conclusions

  • Harry Markowitz revolutionized the way individuals and institutions invest by developing MPT, a groundbreaking investment theory that showed that the performance of a single stock is not as important as the performance of an entire portfolio.
  • Markowitz was one of three recipients of the 1990 Nobel Prize in Economics for his theory of portfolio choice, which the Nobel Committee called "the first seminal contribution to the field of financial economics."
  • His MPT theory was also cited by the Nobel Committee as the basis for the Capital Asset Pricing Model (CAPM), the "second major contribution to the theory of financial economics".

Harry Markowitz: creator of modern portfolio theory (1)

(Video) Dr. Harry Markowitz, Father of Modern Portfolio Theory

education and career entry

Markowitz earned an M.A. and a Ph.D. in economics from the University of Chicago, where he studied with famous academics, including economists,Milton Friedmannand Jacob Marschak and the mathematician and statistician Leonard Savage. While still a student, Markowitz was invited to join a respected economic research institute, the Cowles Commission for Research in Economics (nowdie Cowles Foundation an der Yale University), Led byTjalling Koopmans, mathematician, economist and Nobel laureate.

In 1952 Markowitz joined itRAND Corporation, a global policy research institute, where he built large-scale simulation models of logistics. After a stint at General Electric building model factories, he returned to RAND to continue workingSIMSCRIPT, a computer simulation language that allowed researchers to reuse computer code rather than writing new code for each analysis. When he left RAND to foundConsolidated Analysis Centers, Inc(CACI) in 1962 led the commercialization of a proprietary version of SIMSCRIPT. In addition to his current position as an Associate Professor at the Rady School of Management at the University of California, San Diego, Markowitz is the co-founder and chief architect ofguided selection, a San Diego-based financial advisory firm, where he chairs the investment committee.

The development of modern portfolio theory

Speaking to the Nobel Committee in 1990, Harry Markowitz said: “The basic concepts of portfolio theory came to my mind one afternoon in the library reading John Burr Williams' book.Investment Value Theory. Williams suggested that a stock's value should equal the present value of its future dividends. Because future dividends are uncertain, I interpreted Williams' proposal to value a stock based on its expected future dividends. However, if the investor were only interested in the expected value of the bonds, he would only be interested in the expected value of the portfolio; and to maximize the expected value of a portfolio, you only need to invest in a single security."

But Markowitz recognized that investing in a single security "wasn't how investors traded or were supposed to trade." He knew that "investors diversify because they value risk as much as they value return." He also knew that while investors understood the benefits of diversification, they needed tools to determine the optimal level of diversification.

This insight guided Markowitz's design of theEfficient border, an investment tool that maps the level of diversification that offers the greatest return for the investor's desired level of risk. If a particular portfolio falls within the "Efficiency Frontier" section of the chart, it is considered efficient, meaning it offers the maximum return for that investor's risk tolerance. Portfolios outside the efficient portion of the chart have too much risk x return or too little return x risk. Of course, since each investor's risk tolerance and return expectations are different, there is no such thing as an efficient frontier.

The implications of Harry Markowitz's modern portfolio theory

Prior to Harry Markowitz's work on MPT, investing was largely viewed in terms of the performance of individual investments and their current prices. The diversification has been patchy at best.

(Video) Markowitz Model and Modern Portfolio Theory - Explained

MPT and diversification

Although it was not until the 1960s that Markowitz's work was fully appreciated, MPT has become a cornerstone of investment strategy and the benefits of diversification are well understood by all money managers. UntilRobo Advisor, one of the most disruptive technologies in finance, leverages MPT in assembling suggested portfolios for users.

Wall Street

So much of Markowitz's work has become standard practice in portfolio management that the Nobel LaureatePaul Samuelsonsummed up his contribution by stating that "Wall Street stands on the shoulders of Harry Markowitz".


When Markowitz defended his doctoral thesis on the application of mathematics to stock market analysis in 1954, the idea was so new that Milton Friedman remarked that his doctoral thesis was not even economics. In 1992 his ideas were so well received that the economist Peter Bernstein inCapitalidenecalled his development of mathematical and statistical methods for portfolio management "the most famous discovery in the history of modern finance".

risk correlation

Another important influence Markowitz had on economics was that he was the first to understand the importance of valuationrisk correlation— the fact that risk depends not only on the individual risk of each stock, but also on how the values ​​of different stocks rise and fall together.

(Video) Modern Portfolio Theory by Harry Markowitz (explained in layman terms)

Fellow economist Martin Gruber credits Markowitz with the simple — but revolutionary — insight that investors should always evaluate the relationships between stocks, rather than just looking at each stock in isolation.

Criticism of modern portfolio theory

As with any widely held theory, there have been criticisms of MPT.

A common problem is that there's no absolute measure of how many stocks to hold for adequate diversification. It has also been argued that managing a portfolio according to MPT principles will lead risk-averse investors to take more risks than they can tolerate.

Another criticism focuses on the need to go beyond MPT to address systemic risks in the real world.

Going beyond modern portfolio theory

Two critics of Modern Portfolio Theory (MPT) are Jon Lukomnik, executive director of Sinclair Capital and senior fellow at High Meadows Institute, a Boston-based policy institute focused on the role of corporate governance in creating a sustainable society, and James Hawley, Director of Applied Research at TruValue Labs, a San Francisco-based startup offering AI analytics to create sustainability/ESG metrics.

In 2021, Lukomnik and Hawley published a book,Beyond modern portfolio theory: It's about time!to address what they call “the MPT paradox”: the fact that Markowitz's MPT diversification is only for mitigationidiosyncratic risksthat are specific to certain assets, sectors or asset classes - and do nothing to mitigatesystematic risks, which could bring down an entire industry or the entire financial system.

Lukomnik and Hawley acknowledge that MPT was developed decades before certain systemic risks such as climate change, antimicrobial resistance and resource scarcity were recognized as investment problems. However, they argue that these systemic risks to real-world environmental, social, and financial systems are far more important to returns than the idiosyncratic risks associated with individual securities or companies. In their book, they identify the MPT's lack of tools to deal with these real systemic risks as a pressing problem for modern investors.

(Video) Harry Markowitz on Portfolio Theory

What does Markowitz see as the biggest mistake amateur investors make?

Harry Markowitz said that "The retail investor's main mistake is to buy when the market is going up, assuming it will keep going up, and to sell when the market is going down, assuming the market will go down further ."

What does Harry Markowitz think of robo advisors?

When asked if robo-advisors operate on MPT principles, Markowitz affirmed, “They're a way of giving advice to the crowd. Robo advisors can give good or bad advice. If the advice is good, great.”

What did Markowitz call his "a-ha" moment?

Markowitz's "aha" moment came while reading a book on mathematical probability - and he had his famous flash of inspiration on risk correlation: "Portfolio volatility depends not only on constituent volatility, but also on how much." they walk up and down together.”


Since developing Modern Portfolio Theory (MPT) in 1952, Harry Markowitz has been one of the most important pioneers in the new field of financial economics.

(Video) In Pursuit of the Perfect Portfolio: Harry M. Markowitz

His pioneering work on concepts ranging from portfolio theory to computer programming language laid the foundation for how Wall Street works today.

Markowitz's work also popularized concepts such as diversification and overall portfolio risk and return, shifting the focus away from the performance of individual stocks.


What is Harry and Markowitz modern theory? ›

Markowitz created a formula that allows an investor to mathematically trade off risk tolerance and reward expectations, resulting in the ideal portfolio. MPT works under the assumption that investors are risk-averse, preferring a portfolio with less risk for a given level of return.

Is modern portfolio theory and Markowitz theory same? ›

The Markowitz model is a method of maximizing returns within a calculated risk. It is also called the Markowitz portfolio theory or modern portfolio theory.

What is meant by Markowitz portfolio theory? ›

A key component of the MPT theory is diversification. Most investments are either high risk and high return or low risk and low return. Markowitz argued that investors could achieve their best results by choosing an optimal mix of the two based on an assessment of their individual tolerance to risk.

What did Harry Markowitz do? ›

The first pioneering contribution in the field of financial economics was made in the 1950s by Harry Markowitz who developed a theory for households' and firms' allocation of financial assets under uncertainty, the so-called theory of portfolio choice.

What are the 2 key ideas of modern portfolio theory? ›

Modern portfolio theory helps investors minimize market risk while maximizing return. It starts with two fundamental assumptions: You cannot view assets in your portfolio in isolation. Instead, you must look at them as they relate to each other, both in terms potential return and the level of risk each asset carries.

What is the key lesson of modern portfolio theory? ›

Key Takeaways

Modern portfolio theory is an investing strategy. It focuses on minimizing market risk while maximizing returns. MPT uses diversification to spread investments across different asset classes. That creates higher returns at lower levels of risk.

Who is the father of portfolio theory? ›

Since he developed Modern Portfolio Theory (MPT) in 1952, Harry Markowitz has been one of the most important pioneers of the new field of financial economics.

What are the three assumptions of Markowitz model? ›

Markowitz made the following assumptions while developing the HM model: Risk of a portfolio is based on the variability of returns from said portfolio. An investor is risk averse. An investor prefers to increase consumption.

What is the criticism of Markowitz theory? ›

The theory has been criticised for its reliance on variance as the sole risk factor used in optimisation, and a perception that it depends on the assumption of Gaussian returns that dramatically underestimate the chance of extreme market moves. Markowitz is incensed by the last criticism in particular.

What is the goal of Markowitz analysis? ›

Key Takeaways. The Markowitz efficient set was developed by economist Harry Markowitz in 1952. The goal of the Markowitz efficient set is to maximize the returns of a portfolio for a given level of risk. The efficient solution to a portfolio can be plotted on the Markowitz efficient frontier.

How does Harry Markowitz invest? ›

Markowitz is of the view that a smart investor just buys and holds a well-diversified portfolio, using index funds. Markowitz says that equity portfolios should be diversified with different types of stocks like large-cap, small-cap, value, growth, foreign and domestic stocks. "Your portfolio should also be efficient.

How did Harry Markowitz make his money? ›

In the private sector, he was a consultant to General Electric between two stints as research associate at the Rand Corp. On top of making shrewd stock market investments, Markowitz has built wealth through real estate.

What is the base of explanation to Markowitz hypothesis? ›

The research studies have shown that random diversification will not lead to superior returns unless it is scientifically predicted. Markowitz theory is also based on diversification. He believes in asset correlation and in combining assets in a manner to lower risk.

What is the problem with MPT? ›

MPT has inherent limitations: investors are not always rational, and they do not always select the less-risky portfolio. Investors often chase returns, gravitating to a hot manager or asset class, especially during bull markets.

What are the downsides of MPT? ›

Downsides to MPT

Sometimes it demands that the investor take on a perceived risky investment (futures, for example) in order to reduce overall risk. That can be a tough sell to an investor not familiar with the benefits of sophisticated portfolio management techniques.

Is modern portfolio theory still relevant? ›

Modern Portfolio Theory is valid; it is more descriptive rather than prescriptive, but most of the theory relies on assumptions that are often incorrect. Luckily, we have behavioral finance to add some rationality to MPT, reminding us that we can hope the market is stable.

What is the disadvantage of modern portfolio theory? ›

Disadvantages of the Modern Portfolio Theory (MPT)

Considering only the past performances sometimes leads to overpassing the newer circumstances, which might not be there when historical data were considered but could play an important role in making the decision. This theory assumes that there is a normal distribution.

Where did modern portfolio theory come from? ›

In the 1950s, Harry Markowitz created Modern Portfolio Theory (MPT), which has served as the foundation for how wealth managers build investment portfolios for their clients. Harry Markowitz won the Nobel Prize in Economics in 1990 for this work.

Who first introduced the portfolio system? ›

This procedure was legalized by the Indian Councils Act, 1861 during the time of Lord Canning, leading to the introduction of the portfolio system and the inception of the Executive Council of the Governor-General.

What is the formula of Markowitz model? ›

α = µb − mT wmin-var mT v . It is remarkable that every solution to the Markowitz problem M can be represented as a linear combination of only two portfolios. These being the the minimum variance portfolio with weights wmin-var and our market portfolio with weights wmk.

What are the conclusions of Markowitz model? ›

Markowitz's portfolio theory essentially concludes that beating the market requires taking more risk, and this risk eventually becomes quantified by the term we know today called beta.

What theory was Harry Markowitz coined in 1952? ›

Since he developed Modern Portfolio Theory (MPT) in 1952, Harry Markowitz has been one of the most important pioneers of the new field of financial economics.

What is the modern portfolio theory and what are the criticism of this theory? ›

According to Modern portfolio theory, an investor invests with the motive of taking the minimum level of risk and earning the maximum amount of return with that minimum risk taken, so in the present case, one should choose the second portfolio as he is getting the same average expected return with the less level of ...


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