TOPIC:

Harry Markowitz

PRESENTED BY
ZAIB RAHMAN 11_002

Biography
Real Name: Harry Max Markowitz Known As: Harry Markowitz Place of Birth: Chicago, Illinois, United States Born / Date of Birth: Aug 24 1927 Age: 84 years Occupation Category: Writers

 Harry Markowitz was born on August 24, 1927 in Chicago, to his Jewish parents Morris and Markowitz. During high school, Markowitz developed an interest in physics and philosophy. After receiving his B.A in economics., Markowitz decided to continue his studies at the University of Chicago, choosing to specialize in economics. While still a student, he was invited to become a member of the Commission for Research in Economics, which was in Chicago at the time.

Conti.

 Markowitz chose to apply mathematics to the analysis of the stock market as the topic for his dissertation. While researching the current understanding of stock prices, which at the time consisted in the present value model of John Burr Williams, Markowitz realized that the theory lacks an analysis of the impact of risk. This insight led to the development of his seminal theory of portfolio allocation under uncertainty, published in 1952 by the Journal of Finance

Time line
1950 Received MA from the University of Chicago. 1952 Appointed as researcher at the RAND Corporation. 1954 Received PhD from the University of Chicago. 1955 Invited to be a student member of the Cowles Foundation for Research in Economics. 1959 Publication of Portfolio Selection. 1962 Co-founded CACI International. 1962 Publication of SIMSCRIPT: A Simulation Programming Language. 1963 Worked at the Consolidated Analysis Centers, Inc. 1968 Taught at the University of California, Los Angeles. 1969 Worked at the Arbitrage Management Co.

1974
Worked at IBMs TJ Watson Research Center.

1983
Appointed Professor of Finance at Baruch College, City University of New York.

1990
Received the Nobel Memorial Prize in Economics.

1994
Appointed Professor of Economics at the Rady School of Management, University of California, San Diego.

Books Written

Most Popular books

Portfolio Selection: Efficient Diversification of Investments by Harry M. Markowitz (Sep 3, 1991) The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies (Apr 5, 2011) Equity Valuation and Portfolio Management (
Oct 4, 2011) Mean-Variance Analysis in Portfolio Choice and Capital Markets by Harry M. Markowitz,

Awards
John von Neumann Theory Prize (1989) The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (1990)

Major Selected publications

"Portfolio Selection". The Journal of Finance. "The Utility of Wealth". The Journal of Political Economy. "The Elimination Form of the Inverse and Its Application to Linear Programming". Management Science.

Current Work
He currently serves on the Advisory Board of Sky View Investment Advisors. Markowitz also serves on the Investment Committee of LWI Financial Inc and as an advisor to the Investment Committee of 1st Global, a Dallas, Texas-based wealth management and investment advisory firm. Dr. Markowitz is co-founder and Chief Architect of GuidedChoice.

Conti
Dr. Markowitzs more recent work has included designing the backbone software analytics for the Guided Choice investment solution and heading the Guided Choice Investment Committee. He is actively involved in designing the next step in the retirement process: assisting retirees with wealth distribution through Guided Spending.

Research Contributions
Modern Portfolio Theory Efficient Frontier Sparse matrix method SIMSCRIPT

Sparse matrix method

Sparse matrix methods are now widely used to solve very large systems of simultaneous equations whose coefficients are mostly zero.

SIMSCRIPT
SIMSCRIPT has been widely used to program computer simulations of manufacturing, transportation, and computer systems as well as war games. SIMSCRIPT (I) included the Buddy memory allocation method, which was also developed by Markowitz. The company that would become CACI International was founded by Herb Karr and Harry Markowitz on July 17, 1962 as California Analysis Center. They helped develop SIMSCRIPT, the first simulation programming language, at RAND and after it was released to the public domain, CACI was founded to provide support and training for SIMSCRIPT.

 A Markowitz Efficient Portfolio is one where diversification can lower the portfolio's risk for a given return expectation. The Markowitz Efficient Frontier is the set of all portfolios that will give 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. Markowitz also co-edited the textbook The Theory and Practice of Investment Management with Frank J. Fabozzi

Harry Markowitz Model

Harry Markowitz put forward this model in 1952. It assists in the selection of the most efficient by analyzing various possible portfolios of the given securities. By choosing securities that do not 'move' exactly together. . The HM model is also called Mean-Variance Model due to the fact that it is based on expected returns (mean) and the standard deviation (variance) of the various portfolios.

 Risk of a portfolio is based on the variability of returns from the said portfolio. An investor is risk averse. The investor's utility function is concave and increasing, due to his risk aversion and consumption preference. Analysis is based on single period model of investment. An investor either maximizes his portfolio return for a given level of risk or maximum return for minimum risk. An investor is rational in nature.

Assumption while developing the HM model

Conti.
To choose the best portfolio from a number of possible portfolios, each with different return and risk, two separate decisions are to be made : 1. Determination a set of efficient portfolios. 2. Selection of best portfolio out of the efficient set.

Determination a set of efficient portfolios

A portfolio that gives maximum return for a given risk, or minimum risk for given return is an efficient portfolio. Thus, portfolios are selected as follows. (a) From the portfolios that have the same return, the investor will prefer the portfolio with lower risk, and (b) From the portfolios that have the same risk level, an investor will prefer the portfolio with higher rate of return

 The shaded area PVWP includes all the possible securities an investor can invest in. The efficient portfolios are the ones that lie on the boundary of PQVW. For example, at risk level x2, there are three portfolios S, T, U. But portfolio S is called the efficient portfolio as it has the highest return, y2, compared to T and U. All the portfolios that lie on the boundary of PQVW are efficient portfolios for a given risk level.

 The boundary PQVW is called the Efficient Frontier. All portfolios that lie below the Efficient Frontier are not good enough because the return would be lower for the given risk

Choosing the best Portfolio

For selection of the optimal portfolio or the best portfolio, the risk-return preferences are analyzed. An investor who is highly risk averse will hold a portfolio on the lower left hand of the frontier, and an investor who isnt too risk averse will choose a portfolio on the upper portion of the frontier

Utility curves
Figure 2 shows the risk-return indifference curve for the investors. Indifference curves C1, C2 and C3 are shown. Each of the different points on a particular indifference curve shows a different combination of risk and return, which provide the same satisfaction to the investors. Each curve to the left represents higher utility or satisfaction. The goal of the investor would be to maximize his satisfaction by moving to a curve that is higher.

Portfolio selection
The investor's optimal portfolio is found at the point of tangency of the efficient frontier with the indifference curve. This point marks the highest level of satisfaction the investor can obtain. This is shown in Figure 3. R is the point where the efficient frontier is tangent to indifference curve C3, and is also an efficient portfolio

Conti.
. Any other portfolio, say X, isn't the optimal portfolio even though it lies on the same indifference curve as it is outside the efficient frontier. Portfolio Y is also not optimal as it does not lie on the indifference curve, even though it lies in the portfolio region. Another investor having other sets of indifference curves might have some different portfolio as his best/optimal portfolio

In Case of Rf Securitas
it is possible to include risk-free securities in a portfolio as well. A portfolio with risk-free securities will enable an investor to achieve a higher level of satisfaction. This has been explained in Figure

In Case of Rf Securitas
R1 is the risk-free return, or the return from government securities, as government securities have no risk. R1PX is drawn so that it is tangent to the efficient frontier. Any point on the line R1PX shows a combination of different proportions of risk-free securities and efficient portfolios. The satisfaction an investor obtains from portfolios on the line R1PX is more than the satisfaction obtained from the portfolio P. All portfolio combinations to the left of P show combinations of risky and risk-free assets, and all those to the right of P represent purchases of risky assets made with funds borrowed at the risk-free rate

Conti
In the case that an investor has invested all his funds, additional funds can be borrowed at risk-free rate and a portfolio combination that lies on R1PX can be obtained. R1PX is known as the Capital Market Line (CML). this line represents the riskreturn trade off in the capital market. The CML is an upward sloping curve, which means that the investor will take higher risk if the return of the portfolio is also higher. The portfolio P is the most efficient portfolio, as it lies on both the CML and Efficient Frontier

 In the market for portfolios that consists of risky and risk-free securities, the CML represents the equilibrium condition. The Capital Market Line says that the return from a portfolio is the risk-free rate plus risk premium. The CML equation is : RP = IRF + (RM - IRF)P/M

RP = IRF + (RM - IRF)P/M RP = Expected Return of Portfolio RM = Return on the Market Portfolio IRF = Risk-Free rate of interest M = Standard Deviation of the market portfolio P = Standard Deviation of portfolio

 (RM - IRF)/M is the slope of CML. (RM - IRF) is a measure of the risk premium, or the reward for holding risky portfolio instead of risk-free portfolio. M is the risk of the market portfolio. Therefore, the slope measures the reward per unit of market risk

The characteristic features of CML

1. At the tangent point, i.e. Portfolio P, is the optimum combination of risky investments and the market portfolio. 2. Only efficient portfolios that consist of risk free investments and the market portfolio P lie on the CML. 3. CML is always upward sloping as the price of risk has to be positive. A rational investor will not invest unless he knows he will be compensated for that risk

Demerits of the HM Model

1. It requires lots of data to be included. An investor must obtain variances of return, covariance of returns and estimates of return for all the securities in a portfolio. 2. There are numerous calculations involved that are complicated because from a given set of securities, a very large number of portfolio combinations can be made. 3. The expected return and variance will also have to computed for each securities