Abstract
We describe the narrative framework called modern portfolio theory, including mean-variance optimization, the capital asset pricing model, arbitrage pricing theory, and the efficient markets hypothesis, that serves as a foundation for asset allocation and performance attribution in the investment management industry. We evaluate its key assumptions and implications. We then examine the financial and social objectives of universal asset owners and their methods of achieving those goals. In practice, sustainable portfolio choice requires a consideration of a far wider set of systemic risk factors than is dreamt of in modern portfolio theory, solutions to the principal-agent problem in financial intermediation and investor efforts at addressing collective action problems.
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Notes
- 1.
See Chapter 1 of Davis, Lukomnik, and Pitt-Watson (2006) for an account of the transition between 1970 and 2004 from primary ownership of the world’s largest corporations by wealthy individuals to the dominance of institutionalized investment vehicles that pool the savings of the citizen investor.
- 2.
In a famous articulation of this view, Milton Friedman argues that a theory that assumes that leaves consciously change their placement and orientation on a tree to maximize exposure to sunlight might be a good theory if its implications fit empirical reality, even though few would agree to ascribe consciousness to leaves (Friedman, 1953). Friedman’s methodological positivism has been criticized by other economists (Caldwell, 1982). See also Wilson (2012) and Gould and Lewontin (2006).
- 3.
For an example of performance attribution in this vein, see Perold (2004).
- 4.
Szegö notes that the Markowitz model is applicable only to the case of elliptic distributions, like normal or t-distributions with finite variances, but not to symmetric distributions with fat tails or to asymmetric distributions.
- 5.
And either underweighting, eschewing, or shorting large-capitalization stocks.
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Bose, S., Dong, G., Simpson, A. (2019). Sustainable Investing and Asset Allocation at Global Scale. In: The Financial Ecosystem. Palgrave Studies in Impact Finance. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-05624-7_10
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