Harry Markowitz was born in Chicago, Illinios on August 24, 1927. He received his bachelor’s degree and Ph.D. in economics from the University of Chicago. While attending the University of Chicago he was selected to join the elite Cowles Commission for Research in Economics. After completing his college career, Markowitz joined the RAND Corporation in 1952.
Harry Markowitz received the Nobel Prize for Economics in 1990, along with William Sharp and Merton Miller, for their contributions to financial economics. In the 1950s Markowitz developed the Modern Portfolio Theory, which illustrates how investment risks in the financial market can have a maximized return. In 1952, Markowitz published his article “Portfolio Selection,” which explains his theory. Markowitz utilized mathemetics and computer methods applied to realistic problems, such as uncertainty in business decisions. 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.
A Markowitz Efficient Portfolio is one where no added diversification can lower the portfolio's risk for a given return expectation (alternately, no additional expected return can be gained without increasing the risk of the portfolio). The Markowitz Efficient Frontier is the set of all portfolios that will give you the highest expected return for each given level of risk. These concepts of efficiency were essential to the development of the Capital Asset Pricing Model.
Since 1982, Markowitz has taught economics at Baruch College at the City University of New York.
The following press release from the Royal Swedish Academy of Sciences describes Markowitz’s work:
Financial markets serve a key purpose in a modern market economy by allocating productive resources among various areas of production. It is to a large extent through financial markets that saving in different sectors of the economy is transferred to firms for investments in buildings and machines. Financial markets also reflect firms' expected prospects and risks, which implies that risks can be spread and that savers and investors can acquire valuable information for their investment decisions.
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. This theory analyzes how wealth can be optimally invested in assets which differ in regard to their expected return and risk, and thereby also how risks can be reduced.
A second significant contribution to the theory of financial economics occurred during the 1960s when a number of researchers, among whom William Sharpe was the leading figure, used Markowitz's portfolio theory as a basis for developing a theory of price formation for financial assets, the so-called Capital Asset Pricing Model, or CAPM.
A third pioneering contribution to financial economics concerns the theory of corporate finance and the evaluation of firms on markets. The most important achievements in this field were made by Merton Miller, initially in collaboration with Franco Modigliani (who received the Alfred Nobel Memorial Prize in Economic Sciences in 1985 mainly for other contributions). This theory explains the relation (or lack of one) between firms' capital asset structure and dividend policy on one hand and their market value on the other.
Harrv M. Markowitz
The contribution for which Harry Markowitz now receives his award was first published in an essay entitled "Portfolio Selection" (1952), and later, more extensively, in his book, Portfolio Selection: Efficient Diversification (1959). The so-called theory of portfolio selection that was developed in this early work was originally a normative theory for investment managers, i.e., a theory for optimal investment of wealth in assets which differ in regard to their expected return and risk. On a general level, of course, investment managers and academic economists have long been aware of the necessity of taking returns as well as risk into account: "all the eggs should not be placed in the same basket". Markowitz's primary contribution consisted of developing a rigorously formulated, operational theory for portfolio selection under uncertainty - a theory which evolved into a foundation for further research in financial economics.
Markowitz showed that under certain given conditions, an investor's portfolio choice can be reduced to balancing two dimensions, i.e., the expected return on the portfolio and its variance. Due to the possibility of reducing risk through diversification, the risk of the portfolio, measured as its variance, will depend not only on the individual variances of the return on different assets, but also on the pairwise covariances of all assets.
Hence, the essential aspect pertaining to the risk of an asset is not the risk of each asset in isolation, but the contribution of each asset to the risk of the aggregate portfolio. However, the "law of large numbers" is not wholly applicable to the diversification of risks in portfolio choice because the returns on different assets are correlated in practice. Thus, in general, risk cannot be totally eliminated, regardless of how many types of securities are represented in a portfolio.
In this way, the complicated and multidimensional problem of portfolio choice with respect to a large number of different assets, each with varying properties, is reduced to a conceptually simple two-dimensional problem - known as mean-variance analysis. In an essay in 1956, Markowitz also showed how the problem of actually calculating the optimal portfolio could be solved. (In technical terms, this means that the analysis is formulated as a quadratic programming problem; the building blocks are a quadratic utility function, expected returns on the different assets, the variance and covariance of the assets and the investor's budget restrictions.) The model has won wide acclaim due to its algebraic simplicity and suitability for empirical applications.
Generally speaking, Markowitz's work on portfolio theory may be regarded as having established financial micro analysis as a respectable research area in economic analysis.