Markowitz, Harry M.
Markowitz, Harry M. 1927-
Harry Max Markowitz was born in Chicago, Illinois, on August 24, 1927, the only child of Morris and Mildred Markowitz. While he grew up during the Great Depression, his parents, who owned a small grocery store, were more than adequately able to provide for him during some difficult economic times in the United States. During his high school years, Markowitz developed an interest in philosophy that continued throughout his college years. After completion of his bachelor of philosophy degree in 1947, however, Markowitz decided to study economics.
Markowitz was particularly drawn to the “economics of uncertainty” through works by John von Neumann, Oskar Morgenstern, Jacob Marschak, and Leonard J. Savage. He received his MA in 1950 and his PhD in 1954. While at the University of Chicago, Markowitz was selected to join the prestigious Cowles Commission for Research in Economics. Markowitz developed the basic concepts of portfolio theory while working on his doctoral dissertation at the University of Chicago. In his brief autobiography published by the Nobel Foundation, he noted that his basic ideas for portfolio theory came to him while reading John Burr Williams’s Theory of Investment Value (1938). Markowitz introduced modern portfolio theory to the world with his paper “Portfolio Selection,” which appeared in the March 1952 issue of the Journal of Finance. He later published a more extensive explanation of portfolio theory in his book Portfolio Selection: Efficient Diversification of Investments (1959).
Before Markowitz’s research, investors focused on evaluating the risks and rewards of individual securities when creating their portfolios. The goal of portfolio management was to identify individual securities that offered the highest expected return for a given level of risk and then build a portfolio from these securities. Correspondingly, if pharmaceutical company stocks had good risk–reward characteristics, then an investor could infer that creation of a portfolio entirely from these stocks was optimal. Markowitz formalized the intuition, however, that this logic was flawed. Formulating a mathematics of diversification, he asserted that investors should select portfolios based on their overall risk–reward characteristics. From the entire universe of possible portfolios, the ones that optimally balance risk and reward belong to what Markowitz called an efficient frontier of portfolios. Specifically, a portfolio on the efficient frontier is one in which: (1) no additional diversification can decrease the portfolio’s risk for a given expected return, and (2) no additional expected return can be gained without increasing the portfolio’s risk. Markowitz proposed that investors should select portfolios from those that lie on the efficient frontier. This work is considered by many to be the first pioneering contribution in the field of financial economics.
An indirect but significant additional contribution by Markowitz to the theory of financial economics occurred through the use of Markowitz’s portfolio theory as a basis for developing the capital asset pricing model (CAPM). Thus, Markowitz’s work on portfolio theory is regarded by many as establishing financial microanalysis as a prominent research area within economics and finance. Markowitz’s work is also consistent with the Modigliani-Miller theorem, which implies that it is not in the interest of investors for firms to reduce risk through diversification, because investors can achieve diversification through their own portfolio choices.
Markowitz’s work is not without criticism. Many challenge his assumption that rational investors are risk averters. In the world of speculation in financial markets, market bubbles and herd behavior do occur. In these situations, investors often demonstrate behavior of seeking risk or ignoring risk or both. Markowitz’s work is also in conflict with the efficient market hypothesis, which implies that portfolio management is of limited value.
Upon leaving the University of Chicago in the early 1950s, Markowitz concentrated primarily on the application of mathematics and computer methods to problems of business decisions under uncertainty. Markowitz spent ten years on the research staff at the Rand Corporation. He then held various positions with Consolidated Analysis Centers, Inc. (1963–1968), the University of California at Los Angeles (1968–1969), Arbitrage Management Company (1969–1972), and International Business Machines Corporation’s T.J. Watson Research Center (1974–1983) before becoming a faculty member of Baruch College of the City University of New York in 1982. His most notable work falls in the areas of portfolio theory, sparse matrix techniques, and the SIMSCRIPT programming language. In 1989 he was awarded the von Neumann Prize in Operations Research Theory by the Operations Research Society of America and the Institute of Management Sciences. In 1990 Markowitz shared (with Merton H. Miller and William F. Sharpe) the Nobel Prize for Economics for theories on evaluating stock market risk and reward and on valuing corporate stocks and bonds.
SEE ALSO Efficient Market Hypothesis; Modigliani-Miller Theorems; Von Neumann, John
BIBLIOGRAPHY
Markowitz, Harry M. 1991. Harry M. Markowitz—Autobiography. In Les Prix Nobel: The Nobel Prizes 1990, ed. Tore Frängsmyr. Stockholm: Nobel Foundation. http://nobelprize.org/nobel_prizes/economics/laureates/1990/markowitz-autobio.html.
Vicki L. Bogan