Modern Portfolio Theory and Quantum Mechanics

Abstract

Using the fortuitous confluence of two events, the 50th anniversary of the publication of Harry Markowitz' seminal paper on mean-variance optimization and the 100th anniversary of Lord Kelvin's articulation of the atomic model (launching what we now know as quantum mechanics), the author examines selected limits to the usefulness of Modern Portfolio Theory and draws conclusions as to areas where other approaches are as likely as MPT to provide helpful insights to investors. The article starts with a review of the critical assumptions underpinning MPT and then reviews implications on important decisions such as the classification of asset classes, the use of anchor to windward in individual portfolios, the role and use of hedge funds, real estate, or hard assets, and the redefinition of risk. It concludes that a thorough understanding of the assumptions underpinning any tool or process is critical to ensure the usefulness of the model's recommendations and suggests that there are significant limits to the usefulness of the MPT framework in the field of private asset management.