Harry Markowitz

Nobel 1990 | How important is the diversification of risk?

Fellow Nobel Laureate Paul Samuelson allegedly uttered, “Wall Street stands on the shoulders of Harry Markowitz.” Whether he actually said this is a matter for debate but the sentiment is true. Markowitz didn’t create Wall Street but he is responsible, almost singlehandedly, for the Wall Street we know today.

Harry M. Markowitz

Harry Markowitz

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, 1990 (shared)

At a glance

Born: 1927, Chicago, Illinois, USA

Field: Financial Economics

Prize-winning work: Pioneering work in portfolio management theory for individual wealth holders

His three heroes: John von Neumann, Leonard J. Savage and George Dantzig

A piece of advice: Diversify and start young

On art connections: "Shakespeare is to literature, what Bach is to music"

Life credo: "You can judge a man by his friends"

On teaching a class: Never tell a joke at the beginning of a class - it always falls flat

How Harry Markowitz revolutionize the way we invest?

As a 24-year-old graduate student at the University of Chicago, Markowitz wrote an article on portfolio selection that, in 1990, won him the Nobel Prize. In the almost four decades it took for him to receive the award, he established portfolio theory, influenced the way academic research treated portfolio diversification, revolutionized risk assessment of financial investments, ran a business, consulted others, and developed computer programming language SIMSCRIPT, all the while receiving many other awards and recognitions.

“I was awarded for portfolio theory, which in brief says 'Don’t put all your eggs in one basket.' But there’s a trade-off between return on the average in the long run and variability of return,” he says. “So I worked on the mathematics of risk-return trade-off.”

Diversify as much as you like, but beware of risks

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How did Harry Markowitz prove that diversification doesn't eliminate risk?

Getting to this point warrants a story. In the early 1950s, young Markowitz knew that, according to John Burr Williams in his Theory of Investment Value, the expected value of a stock should be the present value of its future dividend. “So I’m thinking, dividends are uncertain, he must mean an expected value or a mean,” says Markowitz. “Later he even said that if you diversify enough, you will make risk go away and you will get the mean. Well, the notion that if you diversify enough, risk will go away, that’s true of uncorrelated risks.”

Markowitz was two at the start of the Great Depression and has lived to an age where he’s also seen the aftermath of the 2008 crash. “Any fool, especially one who’s lived through the depression or the stock market crashes, can probably see that we have correlated risks and then things do not go to zero,” he says. “But theory was not consistent with practice.”

"Wall Street stands on the shoulders of Harry Markowitz"

Why did Markowitz's work on portfolio theory change the way we think about risk?

Discovering the disconnect between theory and practice set Markowitz on the path to remedy it. Bringing the theory in line with the practice meant searching for a way to mathematically express the change in expected values of dividends and account for correlated risks. This led him to look for the variants and standard deviations of weighted sums in Introduction to Mathematical Probability by J. V. Uspensky in the library. “And that was the a-ha' moment,” he says. “The volatility of the portfolio depends not only on the volatility of the constituents but to what extent they go up and down together.”

However, the implications of this lightbulb moment go much further than the field of investment management. As his longtime friend Martin Gruber describes it, Markowitz’s work “had a major impact on economics because we began to see that you can’t view items in isolation, you have to look at the relationships between them. Whether we’re talking about the relationship between GNP in different countries or two stock markets within the same country. They tend to move together, the extent to which they move together determines the extent to which you can reduce risk. And until Harry’s work, nobody had ever looked at that.”

What’s in a free lunch and how to minimize the risks with efficient frontier?

A life’s goal: Having fun

Needless to say, Uspensky’s book made its way to a special shelf in Markowitz’s office, where he also keeps the leather-bound copy of his own 1959 book, among others that have somehow become important in his life. “Being a small businessman was never my objective,” he says. “Having fun, having interesting problems, having to struggle - that’s the bread and butter, the meat and potatoes. And then the 'a-ha' moments, those are the dessert. But they’re random. They happen all of a sudden.”

Celebrating the 25th anniversary of his Nobel Prize

Across town at the University of California, San Diego (UCSD) campus, guests are gathering to celebrate the results of one particular a-ha moment, the 25thanniversary of Markowitz receiving his Nobel Prize.

Academics, colleagues from the financial industry, friends and family have come from all over the world to honor Markowitz’s life and achievements. Gracefully basking in all the attention, he doesn’t forget to mention that he believes one can tell a man by his friends, and he’s been a lucky one. Having friends and loved ones around him is a prize enough. The laureate engages in conversations with the guests on topics far away from portfolio selections, drawing them in with his broad intellect, knowledge and curiosity. And all this at almost 90 years old!

Harry Markowitz’s greatest hits, and so what?

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“He is every bit as brilliant at 88 as he was at 62,” says John Guerard, a guest and former colleague.

“I was a young smart ass kid,” counters Markowitz. “Now I’m a smart ass old man. And the only thing that’s different between now and then is that I’ve had many, many years to be a smart young kid, a smart middle-aged kid and a smart old man.”

How to find meaning in your work: Harry Markowitz's advice

As we’re saying goodbye, we hear one last time “Well, let me tell you a story,” he says. “When people are effusing over my Nobel Prize, I like to tell them my Nobel Prize was not my greatest honor. My greatest honor was awarded to me in the men’s room of a large Washington DC hotel, after dinner, sometime between Christmas and New Year of 1990.” He’d been invited by the American Finance Association and, after an evening at which Markowitz, along with his co-laureates William Sharpe and Merton Miller said a few words, Markowitz went to use the men’s room. It was here that somebody in the next stall said to him:

’Thank you, Dr. Markowitz, for creating the profession in which we all make our living.’ And that’s better than a Nobel Prize.

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Hear Michael Spence's view on how countries can grow sustainably while having a long-lasting positive impact.

What does Markowitz's work mean for us?

"If there's one thing to be learned working in financial markets, it's that risk or uncertainty is a key part of our lives."

Paul Donovan 
Global Chief Economist UBS Wealth Management

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