Why and how is Modern Portfolio Theory still relevant in todays Black Swan world?
A black swan is defined by investopedia as an event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult to predict. It was popularized by Nassim Nicholas Taleb, a finance professor and hedge fund manager. Another common characterization is the term “fat tails” (i.e., more outliers than would be expected in a normal distribution). Fat tails have always been a part of the investment landscape. They were first identified by Benoit Mandelbrot and Eugene Fama over forty years ago. The real question is whether the existence of fat tails should impact the way we form portfolios, based on Modern Portfolio Theory which tells us to maximize diversification while keeping our risk exposure to an acceptable level. The answer, quite simply, is no. We just need to recognize that from time-to-time, we will have returns that are outside the bounds of our expectations, but this will happen on both the positive and the negative side. Over the
A black swan is defined by investopedia as an event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult to predict. It was popularized by Nassim Nicholas Taleb, a finance professor and hedge fund manager. Another common characterization is the term “fat tails” (i.e., more outliers than would be expected in a normal distribution). Fat tails have always been a part of the investment landscape. They were first identified by Benoit Mandelbrot and Eugene Fama over forty years ago. The real question is whether the existence of fat tails should impact the way we form portfolios, based on Modern Portfolio Theory which tells us to maximize diversification while keeping our risk exposure to an acceptable level. The answer, quite simply, is no. We just need to recognize that from time-to-time, we will have returns that are outside the bounds of our expectations, but this will happen on both the positive and the negative side. Over the
