William F. Sharpe
The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, 1990
His mother wanted him to become a medical doctor, but William F. Sharpe couldn’t stand the sight of blood. However, since education was already a family tradition, he decided to become a different kind of doctor. In doing so, he became a leader in an academic field of his own making: financial economics.
Next to his Nobel co-Laureates Markowitz and Miller, Sharpe is said to be the master of investment. He developed the so-called Capital Asset Pricing Model (CAPM): the first theory to explain why securities have the prices they do, and how prices or returns differ from one another. As a passionate and self-taught programmer, he's also created analytical tools that have radically changed financial markets.
Milk, butter and the Capital Asset Pricing Model
Sharpe’s reputation as a giant in the financial world aside, he's also worked to make economics useful to all parts of society, especially to those less fortunate. Today Sharpe is retired, and this might have aroused a desire to develop strategies for avoiding old-age poverty. But he doesn't underestimate that the impending demographic shift will force the next generations to think about their future sooner in life. It’s up to Sharpe, and us, to teach them how.
If the average Joe wonders why milk is more expensive than butter, or why the price of milk rises but butter remains the same, you can tell them: William Sharpe knows why milk and butter depend on the market price of fish. He’s analyzed and proved how a shift in one market drives the prices of others. It sounds logical these days. But in June 1961, as Sharpe was finishing his dissertation, the basis for the CAPM and single-index model, it was ground-breaking.
At a glance
1934, Boston, Massachusetts
The general theory for the pricing of financial assets, pioneering contribution to the field of financial economics
Wedding and sports photographer, assistant at gas station
Sailing, opera, dogs, programming, playing piano
Did a theory define our financial markets?
Of course, the CAPM isn't simply a model to be used in grocery stores; it shows how Sharpe has contributed to the analysis of financial markets, and gives an idea of why the Nobel Committee has called his work “the backbone of financial economics”. Once Sharpe dives into what the CAPM means for financial markets, understanding it can be a true challenge. Even when he's asked to explain it in simple terms, it's not easy to grasp the main ideas, let alone the overarching impact, of his theory.
But Sharpe, in true professor-mode, succeeds in keeping it clear: “In equilibrium there are a set of portfolios that are efficient, better than others. Those portfolios typically involve a combination of what we now call the market portfolio. A broad portfolio including, in principal, all the available securities in proportion to their market values,” Sharpe says, thoughtfully, as he leans back in his chair.
“Then, the best thing to do is to put some or all of your money in that portfolio and the rest or none into something safe like treasury bonds, bills, treasury inflation-protected securities. If you really want to take on risk and get a higher expected return, you might even want to borrow money, and invest all your money, and the money you borrow, in that market portfolio. Another implication is that the trade-off between expected return and risk will be roughly linear, so if you want more expected return, you’re going to have to take more risk.”
Get new questions as they launch
For people who want to understand Sharpe's work, but can't wrap their heads around it, it's better to ask academics and investors who use his model, and know the laureate well. Martin Gruber, Professor at New York University’s Stern School of Business, clarifies it in just two sentences:
Bill, following Harry Markowitz, developed the first theory of why securities had the prices they had, and later turned that theory into a general equilibrium. It's the first theory that explained why and how the prices or returns on securities differ from each other.
This, in the end, Gruber says, “changed the whole way the industry works.”
Can software help us avoid poverty in old-age?
Out of his own interests in optimization technology and programming, Sharpe has turned his theory into an algorithm that allows everyone to benefit. Following headlines like "No electricity price comes without Sharpe" the economist himself feels uncomfortable being named a "giant of investment" or the "master of finance".
Flattery like this may come with being a Nobel Laureate, but it doesn't keep him from the grindstone. In his home office, with its little piano and numerous paintings of his beloved dogs, the retiree is still reaching new heights. Today he is an ace at programming, and while his tools may not have changed, the topics have.
For nearly two years, Sharpe worked on strategies to produce income during retirement by factoring in thousands of possible future scenarios, market information, market equilibrium, and other circumstances – to assess and evaluate different financial security options for individuals. Of course, this strategy comes along with a software suite he's programmed.
Sharpe has designed it so anyone can use his software. Because, aware of the demographic shift our societies face, he notes that social programs in many countries are not adequately funded, and that private ones are not particularly good. “Many people put their retirement savings in vehicles that are riskier than they understand them to be – it costs more in terms of expenses, going to insurance companies, going to investment managers than is necessary,” he explains.
How can we make financial markets work for everyone?
This kind of work isn't new for Sharpe. Many years ago, he left the academic arena to be a consultant to the private sector. As the founder of William Sharpe Associates, he's been able to combine his research with real-life problems more effectively. During these years he's used his ideas to really help people, in all parts of society. It's also allowed him to maintain a better role in advising those who are less fortunate or who have been tasked with managing a pension or endowment fund.
“I care a lot about what happens to sort of ‘ordinary’ middle and less-than-middle-class people,” Sharpe explains. He notes that as the child of a service member during World War II, he saw the need to take on responsibility and work to make a living during college.
“I was one of the photographers for the school annual, I did mostly sports photography and a couple of weddings,” Sharpe laughs. “But it turned out it was more profitable to work at a gas station at night after classes, so I dropped my photography career and became a specialist in cleaning up gas stations before closing.”
Returning to the average Joe, Sharpe claims to preserve the dual role of education and regulation in order to advise people. He's especially aware of those who can't be expected to understand the complexities of the modern financial system, or be “very adversely affected by investing in funds that, you know, are wildly undiversified.”
Sharpe goes on to state that if the financial sector involves very wealthy people, and very sophisticated people, this would lead to relatively low regulation.
But I’m concerned mostly with people who earn middle or lower incomes, although obviously the lower income people generally don’t have much money to invest.
He finds it hard to believe that we need “millions of derivative products” and are therefore only interested in mutual funds and Exchange Traded Funds (ETFs), which include multiple securities. “Many of these new securities,” Sharpe adds, “are popular primarily for people who are making bets, and nothing against betting but in terms of making people better off, improving the welfare of ordinary investors, I find many, many of these to be superfluous if not dangerous.”
How can we shape our future retirement plans?
Thinking about future generations is a top priority for Sharpe. Whether it's true for Gen Y, Gen X, or Millennials, the current retirement system won't work forever. Planning and saving must start earlier in life.
“It’s very simple to say, well, you gotta work longer and save more!” And, as he anxiously agrees, this is “not a happy” answer. But in his opinion, financial education is a promising step for younger people, especially in emphasizing how important it is to plan for retirement. And even though he doesn't give investment advice to his own mother, he says that “we really need to have education possibly at many levels that will help people get the rudiments, not just 'watch out for the credit card fees' or, you know, the usual simple consumer things.”
A simple change in education, he proclaims, can lead to deeper understanding of daily issues. In summer classes, Sharpe already makes a small difference by teaching 12-year-olds how to program using a language called Scratch. “It’s a marvelous language for being creative and learning all these kinds of habits of logical thinking. I’ve been teaching that partly just to see if it makes sense to argue that this should be done, and after four years of doing this, I feel more strongly than ever that it can be taught; it should be taught.”
Is migration the master plan for aging societies?
As a keen sailor, he knows the maxim: it's not how the wind blows, but how you set the sails. The Nobel Laureate strongly condemns the rise of right-wing parties in Western societies, particularly those linked to conditions of inequality. Instead, he suggests, it's time to recognize immigration as a real prospect.
You need younger people to come into the economy: to be productive and help the economy function and, basically, help support all the old people.
Young immigrants are especially important. “But,” Sharpe admits loudly, “you need an intelligent immigration policy.”
After a four-hour talk, Sharpe isn't even close to getting tired. On the contrary, he seems to wake up after the gentle farewell, because he can finally return to his work – it seems that he'll always have this insatiable desire.
Projection of the world’s population
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