J. V. Bruni and Company
1528 North Tejon Street
Colorado Springs, Colorado 80907
(719) 575-9880 or (800) 748-3409
J. V. Bruni and Company1528 North Tejon Street Colorado Springs, Colorado 80907 (719) 575-9880 or (800) 748-3409
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The
(mis)Behavior of Markets,
by Benoit Mandelbrot.
Mandelbrot
is a well-known mathematics professor and the inventor of fractal
geometry. Perhaps it took someone other than a finance professor to
question some of the mathematical assumptions of Modern Portfolio Theory
(MPT), which underlies the case for efficient markets, indexing, etc.
Mandelbrot notes that implicit in MPT is the assumption that price
changes are normally distributed, and he sets about determining whether
this is the case. After detailed research, he concludes that price
changes are not normally distributed—they are “fatter” in
the tail ends than the bell-shaped normal distribution curve. As a
result, price changes are much more volatile than predicted by MPT. For
example, the stock market crash of October 19, 1987 shouldn’t have
happened in a million years, based on MPT assumptions. Further,
quantitatively-oriented investors (like certain hedge funds)
periodically blow up (think of the Long-Term Capital Management hedge
fund in 1998), because they base their investing strategies on MPT and
are unprepared for periodic highly volatile markets. This is an
important work, and it represents yet another nail in the coffin of MPT. |
“On the scroll of great non-economists who advanced economics by quantum leaps, next to John von Neumann we read the name Benoit Mandelbrot.” Paul A. Samuelson |