Apocalypse revisited: Do you know where your optimizer is at night?.
Portfolio theory is rich, containing mathematical algorithms, statistical analysis, risk measures, utility theory, expectations and investor behavior. Portfolio theory is simply a toolbox of statistical and mathematical tools trying to improve investment decision-making under risk or uncertainty. Portfolio theory is valuable under the right conditions. The problem with portfolio theory, however, derives from Godel's Incompleteness Theorem that states that a mathematical algorithm cannot prove its own validity. Portfolio optimization is a set of simultaneous equations that are solved mathematically in order to minimize expected risk and to maximize expected return. One approach to using portfolio optimization correctly is to generate a macro forecast of the economy. Planners should remember that optimization software is properly used only when it reflects expectations and forecasts.
|Main Author:||Nawrocki, David.|