Workbook for Volume 1 - Part IV – Section #22: Foundational Papers from the 20th Century, Post-World War II (4 of 15) – Graham, Markowitz & Roy
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For returning readers and subscribers: This post introduces a Revised Version for Volume 1 - Part IV – Section #22: Foundational Papers from the 20th Century, Post-World War II (4 of 15) – Graham, Markowitz & Roy
Summary:
Volume 1 - Part IV – Section #22: Foundational Papers from the 20th Century, Post-World War II (4 of 15) – Graham, Markowitz & Roy – Notable “Winners-Take-All” in the “Reputational Hierarchies” of “Expected Value” include Harry Markowitz and his development of Modern Portfolio Theory (MPT). Despite its (i) “Small Worlds” & “Rational Investor” assumptions, (ii) optimizing a single period, (iii) requiring an external “Preferencing Criterion” to provide a recommendation, and (iv) having an unusual implied utility formula [Quadratic Utility], MPT became the dominant, best-practice, portfolio selection process in Financial Economics. Starting with Ole Peters first paper about Ergodicity Economics (EE) in 2010, we now know that the ergodic transformation function of returns into a price trajectory can be interpreted as a utility function. A specific growth dynamic equation implies a specific ergodic transformation function, and vice-versa. A multiplicative “Growth Dynamic” (exponential growth) implies the logarithm as an ergodic transformation function. Thus, the growth dynamic, such as MPT’s, that matches quadratic utility as an ergodic transformation function would be different from the multiplicative growth dynamic that matches the logarithm as an ergodic transformation function. This may explain why, over the last 70 years of financial planning practice that compared a lot of theoretical “quadratic apples” with “logarithmic oranges”, MPT and its derivative theories accumulated a large catalog of empirical “Puzzles, Paradoxes, & Anomalies”. In 2022, a contributor to the peer-review process based on the daily Substack publication of two-page sections from these workbooks made the following connections to place MPT, the Kelly Formula, and other Financial Economics concepts in context: (i) “Expected Value Optimization” addresses ensemble growth at scale, (ii) “Growth Optimal Selection” addresses individual growth at scale, and (iii) “Client-Centric Planning” addresses household-level habitable order. EE articulates the difference between ensemble & individual growth at scale. “Client-centric Planning” articulates the difference between growth at scale & sustainable habitable order. These recent developments provide individual investors with a greater range of choices for financial planning processes in addition to the existing range of investment styles.
Developing…
”CTRI by Francois Gadenne” writes a business book in three volumes, published serially on Substack for public peer-review. The book connects the dots of life-enhancing practices for the next generation, free of controlling algorithms, based on the lifetime experience of a retirement age entrepreneur, & continuously updated with insights from reading Wealth, Health, & Statistics research papers on behalf of large companies as the co-founder of CTRI.