In 1990, U.S. economists Harry Markowitz, William F. Sharpe, and Merton H. Miller shared the Nobel Prize “for their pioneering work in the theory of financial economics.” Their contributions, in fact, were what started financial economics as a separate field of study. In the early 1950s Markowitz developed portfolio theory, which looks at how investment returns can be optimized. Economists had long understood the common sense of diversifying a portfolio; the expression “don’t put all your eggs in one basket” is certainly not new. But Markowitz showed how to measure the risk of various securities and how to combine them in a portfolio to get the maximum return for a given risk.
Say, for example, shares in Exxon and in General Motors have a high risk and a high return, but one share tends to go up when the other falls. This could happen because when OPEC raises the price of oil (and therefore of gasoline), the prices of oil producers’ shares rise and the prices of auto producers’ shares fall. Then a portfolio that includes both Exxon and GM shares could earn a high return and have a lower risk than either share alone. Portfolio managers now routinely use techniques that are based on Markowitz’s original insight.
Markowitz earned his Ph.D. at the University of Chicago. He has taught at Baruch College of the City University of New York since 1982.
About the Author
David R. Henderson is the editor of The Concise Encyclopedia of Economics. He is also an emeritus professor of economics with the Naval Postgraduate School and a research fellow with the Hoover Institution at Stanford University. He earned his Ph.D. in economics at UCLA.