Jully/August 1999
5
PERSPECTIVES
The Early History of Portfolio Theory:
1600–1960
Harry M. Markowitz
iversifcation oF investments was a
well-established practice long beFore I
published my paper on portFolio selection
in 1952. ±or example, A. Wiesenberger’s
annual reports in
Investment Companies
prior to
1952 (beginning 1941) showed that these frms held
large numbers oF securities. They were neither the
frst to provide diversifcation For their customers
(they were modeled on the investment trusts oF
Scotland and England, which began in the middle
oF the 19th century), nor was diversifcation new
then. In the
Merchant of Venice
, Shakespeare has the
merchant Antonio say:
My ventures are not in one bottom trusted,
Nor to one place; nor is my whole estate
Upon the Fortune oF this present year;
ThereFore, my merchandise makes me not sad.
Act I, Scene 1
Clearly, Shakespeare not only knew about diversi-
fcation but, at an intuitive level, understood cova-
riance.
What was lacking prior to 1952 was an ade-
quate
theory
oF investment that covered the eFFects
oF diversiFication when risks are correlated, distin-
guished between eFFicient and ineFFicient portFo-
lios, and analyzed risk–return trade-oFFs on the
portFolio as a whole. This article traces the develop-
ment oF portFolio theory in the 1950s (including the
contributions oF A.D. Roy, James Tobin, and me)
and compares it with theory prior to 1950 (includ-
ing the contributions oF J.R. Hicks, J. Marschak, J.B.
Williams, and D.H. Leavens).
Portfolio Theory: 1952
On the basis oF Markowitz (1952), I am oFten called
the Father oF modern portFolio theory (MPT), but
Roy (1952) can claim an equal share oF this honor.
This section summarizes the contributions oF both.
My 1952 article on portFolio selection proposed
expected (mean) return,
E
, and variance oF return,
V
,
oF the portFolio as a whole as criteria For portFolio
selection, both as a possible hypothesis about actual
behavior and as a maxim For how investors ought to
act. The article assumed that “belieFs” or projections
about securities Follow the same probability rules
that random variables obey. ±rom this assumption,
it Follows that (1) the expected return on the portFolio
is a weighted average oF the expected returns on
individual securities and (2) the variance oF return
on the portFolio is a particular Function oF the vari-
ances oF, and the covariances between, securities
and their weights in the portFolio.
Markowitz (1952) distinguished between eFFi-
cient and ineFFicient portFolios. Subsequently,
someone aptly coined the phrase “eFFicient Fron-
tier” For what I reFerred to as the “set oF eFFicient
mean–variance combinations.” I had proposed that
means, variances, and covariances oF securities be
estimated by a combination oF statistical analysis
and security analyst judgment. ±rom these esti-
mates, the set oF eFFicient mean–variance combina-
tions can be derived and presented to the investor
For choice oF the desired risk–return combination. I
used geometrical analyses oF three- and
Four-security examples to illustrate properties oF