“Portfolio Theory is Alive and well”

Abstract

a r k , which he founded in 1987. Prior to this, he was principal and New York region manager of investment consulting at Mercer-Meidinger-Hanen, Inc., and a senior manager in Peat Marwick's Investment Consulting Group. Mr. Rom holds M . B.A. degrees j o m Columbia University and the University o f Cape Town in South Africa, as well as an M.S. in computer science and mathematics. KATHLEEN W. FERGUSON has been a principal of Sponsor-Software Systems since 1990. She was previously vice president and manager of consulting services at Prudential-Bache Securities, and senior investment analyst at The Equitable L$e Assurance Society. Ms. Ferguson holds a B.B.A. injnancefrom Adelphi University and an M.B.A. injnancefvom New York University. nal of Investing (Sortino and Price [1994], Balzer [1994], and Merriken [1994]).Kaplan and Siegel's rejection of PMPT and endorsement of MVO do not stand up to scrutiny. We show that PMPT is preferable to MVO on theoretical, empirical, and intuitive grounds. Specifically: 0 MVO can, and does, give unreasonable results, while PMPT optimization consistently gives reasonable results. PMPT optimization gives the same or better results than MVO. The MVO assumption that investors "hate variance" is, in fact, a basic weakness of MVO. Downside risk is acknowledged by many 0 0 24 "PORTFOLIO THEORY IS ALIVE

A Brief History of Downside Risk Measures

“…The rest are consistent with Fishburn's utility measures on the downside but not on the upside. w x It's ironic that Rom and Ferguson's 1994 w x reply to Kaplan and Siegel 1994a effectively relies on the wealth of utility functions available with the Bawa-Fishburn LPM model, although in their work they use only one. In their reply, they note the range of investor behavior that can be matched with the LPM measure.…”

“…They followed with a spirited defense of the downside risk measure Ž w x. Rom and Ferguson 1994 and an article summarizing the use of downside risk measures for perfor-Ž m ance m easurem ent Rom and Ferguson w x . 1997᎐1998 .…”