RAND Statistics Seminar Series

The Trouble with Harry (Markowitz)

Presented by James Thompson
Rice University
Thursday, October 23, 2003 4:00 pm
Main Conference Room

Abstract

Two of the traditional paradigms in financial management are reconsidered. The portfolio design algorithm of Markowitz is flawed for numerous reasons. Firstly, Markowitz assumed that volatility and growth were positively correlated. Frequently, the correlation is actually negative. Then Markowitz assumes that volatility is an appropriate surrogate for risk. This is generally not the case. The simugram gives us a ready means for looking at growth and risk simultaneously.

Secondly, the assumptions behind the Black-Scholes equation are shown to be generally inappropriate. It is argued that Black-Scholes theory has been used to make options a device for speculation, and that bear jumps make this very risky indeed, considering the relatively short time horizons of options. The simugram brings forth the real risks involved with option trading.