In this seminal paper, Harry Markowitz is concerned with the investor's choice of a portfolio given his relevant beliefs about future performances of financial assets. Markowitz considers the rule that the investor considers the expected return as desirable and variance of return as undesirable.
Markowitz favours the expected returns - variance of returns (E-V) rule, which states that the investor should diversify and maximize expected return. The author emphasizes the importance of diversification in a portfolio and the consideration of the intercorrelation among the returns from securities.
Markowitz was awarded with the Nobel Prize in Economics for his work on portfolio theory and the analysis of the optimizing investor's behaviour. As an anecdote, Markowitz ended his Nobel Prize Lecture with the following paragraph:
"Finally, I would like to add a comment concerning portfolio theory as a part of the microeconomics of action under uncertainty. It has not always been considered so. For example, when I defended my dissertation as a student in the Economics Department of the University of Chicago, Professor Milton Friedman argued that portfolio theory was not Economics, and that they could not award me a Ph.D. degree in Economics for a dissertation which was not in Economics. I assume that he was only half serious, since they did award me the degree without long debate. As to the merits of his arguments, at this point I am quite willing to concede: at the time I defended my dissertation, portfolio theory was not part of Economics. But now it is."
Some of the questions related to this article are:
(1) Why Markowitz rejects the hypothesis that the investor does (or should) maximize discounted return?
(2) Does the law of large numbers insure that the actual yield of a portfolio will be almost the same as the expected yield?
(3) How can an efficient portfolio be characterized?
(4) Why is it important to consider uncertainty in the analysis of optimizing investor behaviour?
(5) Are mean and variance proper and sufficient criteria for portfolio choice?
(6) According to Markowitz, why the rule E-V serves better as a guide to investment in comparison with "speculative" behaviour?
(7) In practice, do individual investors tend to manage a diversified portfolio?
The article can be found here:
http://www.gacetafinanciera.com/TEORIARIESGO/MPS.pdf
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