True Markowitz or assumptions we break and why it matters
Markowitz (1952, 1959) underlies modern corporate finance literature, from modern portfolio theory, option theory, to risk management (especially value at risk type methodologies). From it, Diversify has entered all languages, such is its power. Terms such as “the only free lunch” have become a way to give praise to Markowitz work. And, just as with all fundamental breakthroughs in the literature it has been extended many directions, sometimes not necessarily to the benefit of the original work, which often gets blamed when one rendition or another breaks down. With almost every MBA graduated believing they know what Markowitz optimization or portfolio theory means, it behooves us to step back and look at some of the basics, the assumptions that are made, the costs of breaking assumptions, and the potential disasters that can occur when those basics behind all of the theories dependent upon Markowitz' original work are ignored.
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- Norland, Erik & Wilford, D. Sykes, 2002. "Leverage, liquidity, volatility, time horizon, and the risk of ruin: A barrier option approach," Review of Financial Economics, Elsevier, vol. 11(3), pages 225-239.
- Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
- Al Janabi, Mazin A.M., 2012. "Optimal commodity asset allocation with a coherent market risk modeling," Review of Financial Economics, Elsevier, vol. 21(3), pages 131-140.
- Norland, Erik & Wilford, D. Sykes, 2002. "Global portfolios should be optimized in excess, not total returns," Review of Financial Economics, Elsevier, vol. 11(3), pages 213-224.
- Benoit Mandelbrot, 1963. "The Variation of Certain Speculative Prices," The Journal of Business, University of Chicago Press, vol. 36, pages 394.
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