In the finance industry, the name Harry Markowitz is synonymous with the seminal investment portfolio creation technique known as mean-variance optimization. In short, Markowitz used mathematical methods to create an “efficient frontier” of asset allocation. Picture a graph which measures assets’ volatility (or standard deviation) on the X axis against their expected return on the Y axis. Each point on the efficient frontier shows the portfolio with the highest possible expected return for a given standard deviation for a certain set of assets.

As groundbreaking as Markowitz’s work was, it is now seen as a starting point for balancing risk and return in investing. Soon after mean variance optimization came measures like Value at Risk (or VaR), which uses a probability distribution to approximate how much an investor might lose at a given confidence level. For instance, an investor could use Value at Risk to guarantee with, say, 95% confidence that their loss would not exceed a certain dollar amount. When implemented, their losses will not exceed that limit 95 out of 100 days. Continue reading →