It has been long time since Harry Markowitz propounded his well-known theory on portfolio selection in 1952 from Rand Corporation. Dozens of academics have developed his model and criticised its limitations over the years.
Nowadays, it can be perceived in the economic literature a heavy stream which suggests that Modern Portfolio theory has been substituted by other alternative methods due to its broadly negative evaluation received over the years by researchers.
The claims are based on a number of burdens that limit the effectiveness of the Markowitz Portfolio theory. Empirical evidence shows systematic problems with the model assumptions underlying the theory that distort the quality of the model predictions. How well the theory assumptions hold the quality of these predictions? Here there are a part of the main criticised assumptions:
Investors centre decisions solely on expected return and risk –measured by the mean and variance of the historical returns on assets, which is the traditional expected returns-variance of returns rule (E-V) propounded by Markowitz. This decision strategy involves a drawback as optimal asset allocations are highly sensitive to small changes in the inputs, especially expected returns, which may lead to that portfolios are not be well diversified. Franz Fuerst (2008), at the University of Reading, proposes to conduct sensitivity tests to understand the effect on asset allocation to changes in expected returns or either to use a more robust approach to developing asset allocations –reverse optimisation.
Investors take a single-period perspective in determining their asset allocation, having the same time horizon, which leads to a drawback. Investors seldom have a single-period perspective. In a multiple-period horizon, even Treasury bills exhibit variability in returns. As Fuerst (2008) holds, including the ‘risk-free asset’ as a risky asset class can help to solve this problem.
All investors are homogenous, in the sense that they all are in agreement as to the parameters necessary, and their values (meaning that information is freely and simultaneously available to all market participants –when it is, of course not), in the investment decision making process –the means, variances and correlations of the returns on various investments.
Financial assets are arbitrary fungible. Real financial shares are usually not fungible.
It is assumed by the model three Efficient Markets Hypothesis (EMH) axioms: investors are equally informed, rational and risk-averse. It is easily observable that information asymmetry does exist and that behavioral economics research collide with the assumptions which assert that investors are rational and risk-averse. Andrei Shleifer (2000), at Harvard University, introduces an alternative view of financial markets dismantling the EMH assumptions with behavioral economics axioms and empirical evidence.
Investors can borrow and lend at the risk-free rate. It entails a drawback due to borrowing rates are always higher than lending rates. Also, certain investors are restricted from purchasing securities on margin. Fuerst (2008) proposes a potential solution by incorporating into Modern Portfolio theory differential borrowing and lending rates.
Assets’ returns are normally distributed. The mean-variance approach is well suited for application in such an environment. There are some examples of when assets’ returns do not have a normal distribution, for example when investors have a special type of utility function like hedge fund investors have, quadratic utility function. If the distribution is non-normal, the variance or the standard deviation could not be the most suitable measure of riskiness to apply on the portfolio. It has been found by researchers that returns usually have negative skew and positive excess kurtosis. Many researchers as Chris Brooks and Harry M. Kat (2002), at the University of Reading and City University of London, respectively, have performed surveys concluding that the distribution of hedge fund returns is non-normal, founding that the published hedge fund indices exhibit relatively low skewness and high kurtosis.
Investors utility function entails maximising expected return and minimising standard deviation of the return. As investors are utility maximisers, they will always swift from one investment to another which has the same expected return but less risk, or one which has the same risk but greater expected return, or one which has both of them.
There are no taxes or transaction costs. Real financial products are subject to both taxes and transaction costs.
Bearing in mind the limitations that Markowitz model can entail, fierce academic criticism can move the roots shaking the tree. In my opinion, economic models try to simplify a given reality to mathematically explain and prove the forces and interactions that share a number of given factors. It seems it is obvious that some models hold better the reality but I would say that it is not a cause of the quality of the model but of the volatility and complexity of the factors involved. Hence, it could be said that the heavy stream that reject the Markowitz model as a suitable method to produce profitable predictions just verify the complex and systematically risky environment that Markowitz model factors are submitted to.
Economy Contradicts Democracy: Russian Markets Boom Amid Political Sabotage
The political game plan laid by the Russian premier Vladimir Putin has proven effective for the past two decades. Apart from the systemic opposition, the core critics of the Kremlin are absent from the ballot. And while a competitive pretense is skilfully maintained, frontrunners like Alexei Navalny have either been incarcerated, exiled, or pushed against the metaphorical wall. All in all, United Russia is ahead in the parliamentary polls and almost certain to gain a veto-proof majority in State Duma – the Russian parliament. Surprisingly, however, the Russian economy seems unperturbed by the active political manipulation of the Kremlin. On the contrary, the Russian markets have already established their dominance in the developing world as Putin is all set to hold his reign indefinitely.
The Russian economy is forecasted to grow by 3.9% in 2021. The pandemic seems like a pained tale of history as the markets have strongly rebounded from the slump of 2020. The rising commodity prices – despite worrisome – have edged the productivity of the Russian raw material giants. The gains in ruble have gradually inched higher since January, while the current account surplus has grown by 3.9%. Clearly, the manufacturing mechanism of Moscow has turned more robust. Primarily because the industrial sector has felt little to no jitters of both domestic and international defiance. The aftermath of the arrest of Alexei Navalny wrapped up dramatically while the international community couldn’t muster any resistance beyond a handful of sanctions. The Putin regime managed to harness criticism and allegations while deftly sketching a blueprint to extend its dominance.
The ideal ‘No Uncertainty’ situation has worked wonders for the Russian Bourse and the bond market. The benchmark MOEX index (Moscow Exchange) has rallied by 23% in 2021 – the strongest performance in the emerging markets. Moreover, the fixed income premiums have dropped to record lows; Russian treasury bonds offering the best price-to-earning ratio in the emerging markets. The main reason behind such a bustling market response could be narrowed down to one factor: growing investor confidence.
According to Bloomberg’s data, the Russian Foreign Exchange reserves are at their record high of $621 billion. And while the government bonds’ returns hover at a mere 1.48%, the foreign ownership of treasury bonds has inflated above 20% for the second time this year. The investors are confident that a significant political shuffle is not on cards as Putin maintains a tight hold over Kremlin. Furthermore, investors do not perceive the United States as an active deterrent to Russia – at least in the near term. The notion was further exacerbated when the Biden administration unilaterally dropped sanctions from the Nord Stream 2 pipeline project. And while Europe and the US remain sympathetic with the Kremlin critics, large economies like Germany have clarified their economic position by striking lucrative deals amid political pressure. It is apparent that while Europe is conflicted after Brexit, even the US faces much more pressing issues in the guise of China and Afghanistan. Thus, no active international defiance has all but bolstered the Kremlin in its drive to gain foreign investments.
Another factor at work is the overly hawkish Russian Central Bank (RCB). To tame inflation – currency raging at an annual rate of 6.7% – the RCB hiked its policy rate to 6.75% from the all-time low of 4.25%. The RCB has raised its policy rate by a cumulative 250 basis points in four consecutive hikes since January which has all but attracted the investors to jump on the bandwagon. However, inflation is proving to be sturdy in the face of intermittent rate hikes. And while Russian productivity is enjoying a smooth run, failure of monetary policy tools could just as easily backfire.
While political dissent or international sanctions remain futile, inflation is the prime enemy which could detract the Russian economy. For years Russia has faced a sharp decline in living standards, and despite commendable fiscal management of the Kremlin, such a steep rise in prices is an omen of a financial crisis. Moreover, the unemployment rates have dropped to record low levels. However, the labor shortage is emerging as another facet that could plausibly ignite the wage-price spiral. Further exacerbating the threat of inflation are the $9.6 billion pre-election giveaways orchestrated by President Putin to garner more support for his United Russia party. Such a tremendous demand pressure could presumably neutralize the aggressive tightening of the monetary policy by the RCB. Thus, while President Putin sure is on a definitive path of immortality on the throne of the Kremlin, surging inflation could mark a return of uncertainty, chip away investors’ confidence: eventually putting a brake on the economic streak.
Synchronicity in Economic Policy amid the Pandemic
Synchronicity is an ever present reality for those who have eyes to see. –Carl Jung
The Covid pandemic has elicited a number of deficiencies in the current global governance framework, most notably its weaknesses in mustering a coordinated response to the global economic downturn. A global economy is not fully “global” if it is devoid of the capability to conduct coordinated and effective responses to a global economic crisis. What may be needed is a more flexible governance structure in the world economy that is capable of exhibiting greater synchronicity in economic policies across countries and regions. Such a governance structure should accord greater weight to regional integration arrangements and their development institutions at the level of key G20 decisions concerning international economic policy coordination.
The need for greater synchronicity in the global economy arises across several trajectories:
· Greater synchronicity in the anti-crisis response across countries and regions – according to the IMF it is a coordinated response that renders economic stimulus more efficacious in countering the global downturn
· Synchronicity in the withdrawal of stimulus across the largest economies – absent such coordination the timing of policy normalization could be postponed with negative implications for macroeconomic stability
· Greater synchronicity in opening borders, lifting lockdowns and other policy measures related to responding to the pandemic: such synchronicity provides more scope for cross-country and cross-regional value-added chains to boost production
· Greater synchronicity in ensuring a recovery in migration and the movement of people across borders.
Of course such greater synchronicity in economic policy should not undermine the autonomy of national economic policy – it is rather about the capability of national and regional economies to exhibit greater coordination during downturns rather than a progression towards a uniform pattern of economic policy across countries. Synchronicity is not only about policy coordination per se, but also about creating the infrastructure that facilitates such joint actions. This includes the conclusion of digital accords/agreements that raise significantly the potential for economic policy coordination. Another area is the development of physical infrastructure, most notably in the transportation sphere. Such measures serve to improve regional and inter-regional connectivity and provide a firmer foundation for regional economic integration.
The paradox in which the world economy finds itself is that even as the current crisis is leading to fragmentation and isolationism there is a greater need for more policy coordination and synchronicity to overcome the economic downturn. This need for synchronicity may well increase in the future given the widening array of global risks such as risks to cyber-security as well as energy security and climate change. There is also the risk of the depletion of reserves to counter the Covid crisis that has been accompanied by a rise in debt levels across developed and developing economies. Also, the speed of the propagation of crisis impulses (that effectively increases with technological advances and globalization) is not matched by the capability of economic policy coordination and efficiency of anti-crisis policies.
There may be several modes of advancing greater synchronicity across borders in international relations. One possible option is a major superpower using its clout in a largely unipolar setting to facilitate greater policy coordination. Another possibility is for such coordination to be supported by global international institutions such as the UN, the WTO, Bretton Woods institutions, etc. Other options include coordination across the multiplicity of all countries of the global economy as well as across regional integration arrangements and institutions.
Attaining greater synchronicity across countries will necessitate changes in the global governance framework, which currently is characterized by weak multilateral institutions at the top level and a fragmented framework of governance at the level of countries. What may be needed is a greater scope accorded to regional integration arrangements that may facilitate greater coordination of synchronicity at the regional level as well as across regions. The advantage of providing greater weight to the regional institutions in dealing with global economic downturns emanates from their greater efficiency in coordinating an anti-crisis response at the regional level via investment/infrastructure projects as well as macroeconomic policy coordination. Regional development institutions also have a comparative advantage in leveraging regional interdependencies to promote economic recovery.
In conclusion, the global economy has arguably become more fragmented as a result of the Covid pandemic. The multiplicity of country models of dealing with the pandemic, the “vaccine competition”, the breaking up of global value chains and their nationalization and regionalization all point in the direction of greater localization and self-sufficiency. At the same time there is a need from greater synchronicity across countries particularly in the context of the current pandemic crisis. Regional integration arrangements and institutions could serve to facilitate such coordination in economic policy within and across the major regions of the world economy.
From our partner RIAC
A New Strategy for Ukraine
Authors: Anna Bjerde and Novoye Vremia
Four years ago, the World Bank prepared a multi-year strategy to support Ukraine’s development goals. This was a period of recovery from the economic crisis of 2014-2015, when GDP declined by a cumulative 16 percentage points, the banking sector collapsed, and poverty and other measures of insecurity spiked. Indeed, we noted at the time that Ukraine was at a turning point.
Four years later, despite daunting internal and external challenges, including an ongoing pandemic, Ukraine is a stronger country. It has proved more resilient to unpredictable challenges and is better positioned to achieve its long-term development vision. This increased capacity is first and foremost the result of the determination of the Ukrainian people.
The World Bank is proud to have joined the international community in supporting Ukraine during this period. I am here in Kyiv this week to launch a new program of assistance. In doing this, we look back to what worked and how to apply those lessons going forward. In Ukraine—as in many countries—the chief lesson is that development assistance is most effective when it supports policies and projects which the government and citizens really want.
This doesn’t mean only easy or even non-controversial measures; rather, it means we engage closely with government authorities, business, local leaders, and civil society to understand where policy reforms may be most effective in removing obstacles to growth and human development and where specific projects can be most successful in delivering social services, particularly to the poorest.
Looking back over the past four years in Ukraine, a few examples stand out. First, agricultural land reform. For the past two decades, Ukraine was one of the few countries in the world where farmers were not free to sell their land.
The prohibition on allowing farmers to leverage their most valuable asset contributed to underinvestment in one of Ukraine’s most important sources of growth, hurt individual landowners, led to high levels of rural unemployment and poverty, and undermined the country’s long-term competitiveness.
The determination by the President and the actions by the government to open the market on July 1 required courage. This was not an easy decision. Powerful and well-connected interests benefited from the status quo; but it was the right one for Ukrainian citizens.
A second area where we have been closely involved is governance, both with respect to public institutions and the rule of law, as well as the corporate governance of state-owned banks and enterprises. Poll after poll in Ukraine going back more than a decade revealed that strengthening public institutions and creating a level playing field for business was a top priority.
World Bank technical assistance and policy financing have supported measures to restore liability for illicit enrichment of public officials, to strengthen existing anticorruption agencies such as NABU and NACP, and to create new institutions, including the independent High-Anticorruption Court.
We are also working with government to ensure the integrity of state-owned enterprises. Our support to the government’s unbundling of Naftogaz is a good example; assistance in establishing supervisory boards in state-owned banks is another. We hope our early dialogue on modernizing the operations of Ukrzaliznytsia will be equally beneficial.
As we begin preparation of a new strategy, the issues which have guided our ongoing work—strengthening markets, stabilizing Ukraine’s fiscal and financial accounts; and providing inclusive social services more efficiently—remain as pressing today as they were in 2017. Indeed, the progress which has been achieved needs to continue to be supported as they frequently come under assault from powerful interests.
At the same time, recent years have highlighted emerging challenges where we hope to deepen and expand our engagement. First, COVID-19 has underscored the importance of our long partnership in health reform and strengthening social protection programs.
The changes to the provision of health care in Ukraine over recent years has helped mitigate the effects of COVID-19 and will continue to make Ukrainians healthier. Government efforts to better target social spending to the poor has also made a difference. We look forward to continuing our support in both areas, including over the near term through further support to purchase COVID-19 vaccines.
Looking ahead, the challenge confronting us all is climate change. Here again, our dialogue with the government has positioned us to help, including to achieve Ukraine’s ambitious commitment to reduce carbon emissions. During President Zelenskyy’s visit to Washington in early September we discussed operations to strengthen the electricity sector; a program to transition from coal power to renewables; municipal energy efficiency investments; and how to tap into Ukraine’s unique capacity to produce and store hydrogen energy. This is a bold agenda, but one that can be realized.
I have been gratified by my visit to Kyiv to see first-hand what has been achieved in recent years. I look forward to our partnership with Ukraine to help realize this courageous vision of the future.
Originally published in Ukrainian language in Novoye Vremia, via World Bank
From ‘Decisive Storm’ to Secret Talks: The Journey of Saudi Conquest of Yemen
In the last days of the spring of 2015, Saudi generals were sitting around a V-shaped table in front of...
Trans-Caspian Gas Pipeline – An ‘apple of discord’ between Azerbaijan and Russia?
A broad range of strategic, economic and cultural ties between Azerbaijan and Russia create an illusion of quite stable bilateral...
The Post-US Withdrawal Afghanistan: India, China and the ‘English Diplomacy’
The recent developments in Afghanistan, the impatient Tri-axis and the emphatic India at SCO, with the ‘English Diplomacy’ at display...
COVID vaccines: Widening inequality and millions vulnerable
Health leaders agree that a world without COVID-19 will not be possible until everyone has equal access to vaccines. More...
Moscow electronic school — the future of education
The Moscow Electronic School (“MES”) project is a cloud-based Internet platform launched in 2016 that unites all educational institutions in...
Economy Contradicts Democracy: Russian Markets Boom Amid Political Sabotage
The political game plan laid by the Russian premier Vladimir Putin has proven effective for the past two decades. Apart...
Over 50 Companies Reporting on Stakeholder Capitalism Metrics as International Support Grows
The World Economic Forum announces today the continued growth of the coalition of companies supporting the Stakeholder Capitalism Metrics initiative....
Economy4 days ago
Russia, China and EU are pushing towards de-dollarization: Will India follow?
Middle East2 days ago
Turkey’s Destruction of Cultural Heritage in Cyprus, Turkey, Artsakh
Americas3 days ago
Was Trump better for the world than Biden, after all?
South Asia4 days ago
Opposing Hindutava: US conference raises troubling questions
Economy3 days ago
A New Strategy for Ukraine
East Asia4 days ago
How China Exacerbates Global Fragility and What Can be Done to Bolster Democratic Resilience to Confront It
Defense3 days ago
A Glimpse at China’s Nuclear Build-Up
Reports4 days ago
Appliance standards and labelling is highly effective at reducing energy use