The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1990
Harry M. Markowitz, Merton H. Miller, William F. Sharpe
I was born on June 16, 1934 in Boston,
Massachusetts. At that time my parents had completed their
undergraduate educations - my father in English literature, my
mother in science. My father was then employed at Harvard University,
working in the placement office.
In 1940, world events led to the activation of my father's National Guard unit and a move to Texas. The subsequent outbreak of World War II required further moves to northern California and finally to southern California.
The majority of my pre-college education was completed in the public schools of Riverside, California, which were excellent. I benefitted there from stimulating teachers and challenging curricula.
In 1951 I enrolled at the University of California at Berkeley, with a plan to major in science en route to a medical degree. A year of the associated courses convinced me that my preferences lay elsewhere. To change both curriculum and locale I transferred to the University of California at Los Angeles with a declared major in Business Administration.
In my first semester at UCLA I took Accounting and Economics--two courses that were required for the Business degree. Both had a major influence on my career. The accounting course dealt primarily with bookkeeping, while the economics course focused on microeconomic theory. I found bookkeeping tedious and light on intellectual content. But I was greatly attracted to the rigor and relevance of microeconomic theory. Hence, I changed my major to Economics. I have since learned to appreciate Accounting on both pragmatic and intellectual grounds, but am delighted that my first brush with it helped turn me towards the field in which I have worked happily throughout my professional life.
I took two degrees in Economics at UCLA before serving in the Army. I received the Bachelor of Arts degree in 1955 and the Master of Arts degree in 1956. While working for the former I was named to Phi Beta Kappa.
Two professors at UCLA had a profound influence on my career.
I was fortunate to serve as a research assistant for J. Fred Weston, a professor of finance in the Business School, and also to take courses from him. Fred first introduced me to the work of Harry Markowitz and to the rest of the challenging and rigorous research that was beginning to revolutionize finance. As part of my PhD program I was subsequently able to take a field in finance with Fred, greatly broadening my understanding of the subject.
Armen Alchian, a professor of economics, was my role model at UCLA. He taught his students to question everything; to always begin an analysis with first principles; to concentrate on essential elements and abstract from secondary ones; and to play devil's advocate with one's own ideas. In his classes we were able to watch a first-rate mind work on a host of fascinating problems. I have attempted to emulate his approach to research ever since. When I returned to pursue the PhD degree, I took a field in microeconomics with Armen and he also served as chairman of my dissertation committee.
After a short period in the Army, I joined the RAND Corporation in 1956 as an Economist. RAND was an almost ideal place for anyone interested in performing research that was both aesthetically pleasing and also pragmatic. During this period path-breaking work in computer science, game theory, linear programming, dynamic programming and applied economics was being done at RAND, both by permanent staff and visitors from major universities. The atmosphere was collegial and the schedule flexible. Most research projects were chosen by the investigators, and additional work on more fundamental issues was encouraged and generously supported. Among other things, I learned computer programming at RAND. Professional editors and colleagues also helped me improve my communication skills, both written and oral.
While at RAND I pursued a PhD degree in Economics at UCLA. I received the degree in 1961. After completing my field examinations in 1960 I began work on a dissertation concerning the economics of transfer prices. At the suggestion of Armen Alchian, my preliminary results were reviewed by another faculty member who had previously done research on the subject. He thought that I should consider some other topic. Fred Weston suggested that I might see if Harry Markowitz, who was then at RAND, had any ideas. He had, and I proceeded to work closely with him on the topic Portfolio Analysis Based on a Simplified Model of the Relationships Among Securities. Although Harry was not on my committee, he filled a role similar to that of dissertation advisor. My debt to him is truly enormous. The dissertation was approved in 1961, at which time I received the PhD degree.
In the dissertation I explored a number of aspects of portfolio analysis based on a model first suggested by Markowitz. At the time I called it the "single index model", although it is now generally termed a "one-factor model". Key is the assumption that security returns are related to each other solely through responses to one common factor. In the dissertation I addressed both normative and positive results. The final chapter, A Positive Theory of Security Market Behavior, included a result similar to that now termed the security market line relationship of the Capital Asset Pricing Model, but was obtained in the limited environment in which returns are generated by a one-factor model.
In 1961 I moved to Seattle to take a position in Finance at the School of Business at the University of Washington. Once settled, I prepared a paper summarizing the normative results from my dissertation; the paper was subsequently published in Management Science in 1963. More importantly, I began work on a generalization of the equilibrium theory contained in the final chapter of the dissertation. By the fall of 1961 I had discovered that a very similar set of results could be obtained without making any assumptions about the number of factors influencing security returns. I first presented this approach at the University of Chicago in January 1962. Shortly thereafter I submitted a paper on the subject to the Journal of Finance. An initially negative report from a referee plus a change in editorship delayed publication until September of 1964. Both in content and title, this paper provided much of the basis for what is now termed the Capital Asset Pricing Model (CAPM).
The CAPM is built using an approach. familiar to every microeconomist. First, one assumes some sort of maximizing behavior on the part of participants in a market; then one investigates the equilibrium conditions under which such markets will clear. Since Markowitz had provided a model for the requisite maximizing behavior, it is not surprising that I was not alone in exploring its implications for market equilibrium. Sometime in 1963, I received an unpublished paper from Jack Treynor containing somewhat similar conclusions. In 1965, John Lintner published his important paper with very similar results. Later, Jan Mossin published a version that obtained the same relationships in a more general setting.
I was at the University of Washington from 1961 through 1968, with the exception of a year spent on leave at RAND. At Washington I taught a wide-ranging set of subjects, covering material from the fields of microeconomics, finance, computer science, statistics, and operations research. As is so often the case, I found that the best way to learn a subject was to teach it. Hopefully, the students did not suffer overmuch from their participation in the process.
My research during this period was as eclectic as my teaching. I worked on extensions of the CAPM and empirical tests of its implications. I also published books on the economics of computers (based on research supported by RAND) and on computer programming.
My years at Washington were busy but highly productive. While I relied heavily on colleagues at RAND and at other universities during this period, I was fortunate to have interested and supportive colleagues in Seattle--most importantly, George Brabb, Stephen Archer and Charles D'Ambrosio.
In 1968, I moved to the University of California at Irvine to participate in an experiment involving the creation of a School of Social Sciences with an interdisciplinary and quantitative focus. For various reasons the expectations of many who participated in the experiment were not fulfilled, leading some of us to go elsewhere. I was fortunate to be invited to take a position at the Stanford University Graduate School of Business, to which I moved in 1970. Before doing so, however, I completed a book, Portfolio Theory and Capital Markets , summarizing both normative and positive work in these areas.
My years at Stanford have been all that anyone with interests in both research and teaching could have desired. Throughout, I have had the benefit of stimulating colleagues and students. Much of my knowledge of finance was gained when I participated in a team of three, teaching the first PhD seminar in the field at Stanford in the early 1970's. Alan Kraus, Bob Litzenberger and I shared not only our experience and knowledge but also an interest in sailing--a sport in which we indulged fairly frequently.
I also learned a great deal from two colleagues, now departed, in the 1970's. Alex Robichek combined a traditionalist's view of finance with a thirst for new ideas; Paul Cootner came to the field with totally fresh and innovative views. Both placed a premium on useful theory. Both contributed much, through research and teaching. Their premature deaths caused a tremendous loss for the field of finance, for Stanford and for me.
Other finance colleagues, presently or formerly at Stanford, from whom I learned much include Anat Admati, Doug Breeden, John Cox, Darrell Duffie, Allan Kleidon, Mike Gibbons, Jack McDonald, George Parker, Paul Pfleiderer, Myron Scholes, and Jim Van Home. Finance students with whom I worked closely included Marcus Bogue, Guy Cooper, Krishna Ramaswamy, and Howard Sosin.
In 1973 I was named the Timken Professor of Finance at Stanford.
In the 1970s I concentrated most of my research effort on issues connected with equilibrium in capital markets and the implications thereof for investors' portfolio choices. Following the passage of key legislation in the U.S. in 1974, I began to study the role of investment policy for funds designed to fulfill pension obligations. I also wrote a textbook, Investments, designed to include institutional, theoretical and empirical material in a form accessible to students in undergraduate and graduate programs. The first edition, published in 1978, met with considerable success. The book, now co-authored by Gordon Alexander, is currently in its fourth edition. I am especially gratified by the fact that a number of universities still consider it appropriate for its intended purpose. A variant, Fundamentals of Investments, also coauthored with Gordon Alexander, published in 1989, has also been well received.
In the course of preparing and revising the Investments text, I found it necessary to extend prior theory, create new theory, and perform new empirical analyses. Perhaps the most fruitful example of this activity is the creation of the binomial option pricing procedure, first published in the 1978 edition of Investments. It provides a discrete-state analogue of the Black-Scholes procedure which assumes a continuous time setting. Given today's computer power, the binomial procedure offers a practical method for evaluating instruments with complex embedded options, and is widely-used.
During this period I served as a consultant first to Merrill Lynch, Pierce, Fenner and Smith and then to Wells Fargo Investment Advisors. In each case my goal was to help put into practice some of the ideas of financial economics.
At Merrill Lynch I was involved primarily in designing services for estimating beta values on a continuing basis for a large set of common stocks and for providing risk-adjusted portfolio performance measurement.
At Wells Fargo I helped with the creation of index funds, passive portfolios tailored to meet investor objectives, estimation of Security Market Lines (and Planes) using forecasts of future cash flows, assessment of portfolio risk, choice of optimal portfolios to track selected indices, and so on. In my opinion, the people at Wells Fargo at the time were among the most creative and innovative in the industry. From them I learned much about the real world of investment. Such knowledge informed my teaching and research in countless ways. Undoubtedly, my greatest debt in this connection is to Bill Fouse, whose vision made Wells Fargo such an exciting and stimulating organization at the time.
I spent the 1976-1977 academic year at the National Bureau of Economic Research as a member of a team studying issues of bank capital adequacy under the direction of Sherman Maisel. My focus was on the relationship between deposit insurance and default risk. The results, published in the Journal of Financial and Quantitative Analysis in 1978, supported the notion of risk-based insurance premia. Empirical work with Laurie Goodman also showed that market values of securities of financial institutions can reveal important information about capital adequacy. The NBER project strongly advocated greater concern with the risk of financial institutions and warned that a system of fixed insurance rates and de facto unlimited coverage with imperfect monitoring and enforcement procedures provides dangerous incentives for those running such institutions to take excessive risk. Would that our results had been heeded by those concerned with savings and loan institutions in the United States in the subsequent decade!
In the latter part of the 1970s I developed a simple yet effective method for finding approximate solutions to a class of portfolio analysis problems. The procedure, described in a Stanford working paper and in my textbook, has been widely implemented, although final publication of the paper describing the algorithm was delayed until 1987, due to confusion at a journal that had planned to publish it.
In 1980 I was elected President of the American Finance Association. I chose as the topic of my Presidential Address, Decentralized Investment Management. My goal was to provide some structure for analyzing the widespread custom of large institutional investors to divide funds among a number of professional investment managers. The subject is interesting both theoretically and practically, and my work on it continues.
In the 1980s I continued to work on issues relating to pension plan investment policy. A theoretical paper on the subject with J. Michael Harrison was completed in 1983. I also became interested in the return-generating process in the U.S. equity market, a subject pioneered by Barr Rosenberg, then at the University of California at Berkeley. This led to an empirical paper on factors in New York Stock Exchange security returns, published in 1982. I also began to focus much of my effort on asset allocation - the allocation of an investor's funds among major asset classes. To make both the ideas and the technology more widely available, I prepared a package that included a book, optimization software and databases, under the title, Asset Allocation Tools. First published in 1985, it is now offered both by the original publisher and by Ibbotson Associates in conjunction with their much larger set of databases.
In 1983, I helped Stanford establish a program in international investment Management, offered jointly, initially, with the International Management Institute in Geneva, and later, with the London Graduate School of Business. The program, extending over a week, is designed for senior investment professionals wishing to obtain a thorough grounding in financial economic theory and the associated empirical research. I served as Co-Director of the program through 1986 and have participated in subsequent years. Independently, I also helped create a three-week program for the Nomura School of Advanced Management, designed to bring much of the same material to investment professionals in Japan, and taught in the program for five years. I also assisted Sidney Cottle, of Financial Research Associates, in preparing seminars designed to communicate the results of recent research to investment practitioners.
In 1986, I took a two-year leave from Stanford to found Sharpe-Russell Research, a firm chartered to perform research and to develop procedures to help pensions, endowments and foundations select asset allocations appropriate to their circumstances and objectives. Supported by several major pension funds and by the Frank Russell Company, and assisted by a talented group of professionals, I was able to bring previous results from the field of financial economics to bear on these important issues and to provide new theoretical and empirical material of relevance. Subsequent to this period, the firm's charter was broadened to include consulting for pensions, endowments and foundations in the area of asset allocation. Published work resulting from these activities covered the areas of integrated asset allocation, dynamic strategies for asset allocation, factor models for evaluating manager styles and performance, and liability hedging.
In 1989, I chose to change status, becoming Timken Professor Emeritus of Finance at Stanford, in order to devote more of my time to research and consulting activities at William F. Sharpe Associates, as my firm is now known. While this involves giving up regular teaching, I have the great fortune to be able to continue to participate in the intellectual life of the school. In addition, I can pursue research with a fine group of colleagues and to provide assistance to (and learn from) a highly sophisticated group of clients.
It has been my great good luck to be able to work with a number of organizations in the investment industry. I served as a Trustee of the College Retirement Equities Fund from 1975 through 1983 and currently serve a trustee for the Research Foundation of the Institute of Chartered Financial Analysts, a committee member for the Institute of Quantitative Research in Finance, and a member of the Council on Education and Research of the Institute of Chartered Financial Analysts. I also serve as a Strategic Advisor for Nikko Securities' Institute of Investment Technology and the Institutional Portfolio Management division of the Union Bank of Switzerland.
I have also received awards from diverse constituencies. I am especially proud to have been the recipient of the American Assembly of Collegiate Schools of Business award for outstanding contribution to the field of business education in 1980 and the Financial Analysts' Federation Nicholas Molodovsky Award for outstanding contributions to the [finance] profession in 1989.
In the course of this long and demanding career, I have enjoyed the influence and example of my parents and step-parents, all of whom pursued further education in mid-career. My father retired as a college president, my mother as an elementary school principal, and my step-father as a public defender. They taught me by example the joys associated with learning and with communicating the results of that learning to others.
I am also fortunate to have two fine children, Deborah and Jonathan, now grown. Both share a love of learning and of communicating knowledge to others, although they have chosen fields far removed from my own. In 1986 I married my wife Kathryn, an accomplished painter, who shares both my personal and my professional life - the latter in her capacity as Administrator of William F. Sharpe Associates. Without her help, encouragement, and support I truly could not have accomplished what I have in the last five years. We enjoy sailing, opera and Stanford football and basketball games, especially when the weather is good, the music well performed and the opponents vanquished.
From Les Prix Nobel. The Nobel Prizes 1990, Editor Tore Frängsmyr, [Nobel Foundation], Stockholm, 1991
This autobiography/biography was written at the time of the award and later published in the book series Les Prix Nobel/Nobel Lectures. The information is sometimes updated with an addendum submitted by the Laureate.
Copyright © The Nobel Foundation 1990