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. Po...

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Journal Title: Journal of Financial Planning Vol. 9; no. 6; pp. 68 -
Author: David Nawrocki
Format: Article
Language: English
Published: December 1996
Online Access: Full Text
Summary: 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.
ISSN: 1040-3981