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URL:  http://boards.fool.com/mpt-is-bunk-first-off-mpt-relies-on-linear-12263977.aspx

Subject:  Re: MPT and Efficient Frontier Date:  3/23/2000  12:59 PM
Author:  solasis Number:  20 of 297

MPT is bunk.

first off, MPT relies on linear mathematics and normal or Gaussian statistics. i don't care what aspect of the market you look at, market behavior does not fit simple Gaussian assumptions. MPT assumes that prices change in a random walk - that is also not true as the market is complex adaptive. on one extreme you have total order which is completly predictable. at the other extreme you have choas, which is completely unpredictable. in between lies complexity, and that is where the market is at - it is neither chaotic nor ordered - it is complex. like all complex systems it is partially predictable but never completely predictable and that is what turns market participants into mad hatters - the partial predictability. the efficient frontier - as defined by MPT - is not stable and likely to become more unstable as time marches on.

bloomberg has had the hurst coefficient on their charts for several years now, the hurst coefficient is essentially an indication of connectiveness of price moves or the relation of one day's (or week or month or year) price move verses it's past price moves. if the movements are totally a random walk - then the hurst coefficient should be 0.5. but if you look at a lot of data you will see that the hurst coefficient- for either individual stocks or for indices is rarely even close to 0.5.

MPT in my mind is akin to the Ptolemaic universe where everything revolved around the earth. it was an elegant theory and on the face of things, prior to telescopes, it seemed to "make sense". but once people started actually making measurements with telescopes and looking at the data as Copernicus did, it was pretty obvious that the sun did not revolve around the earth. MPT in the early 21st century is a similar case. the data just does not fit the model. however, there will always be holdouts - so i'm sure that there will be people talking about beta 100 hundred years from now.

as far as the correlation between the direction (bull or bear) of foreign markets and our own, once again if you look at the data, really look at it, parse it up into different times frames etc, instead of just throwing it all into one pot and running statistical linear regression stats at it, you will see how the correlation has consistently become more positive with time the past 30 years. funny how that works - it wasn't until the 1960's that private US business investment began to go overseas in any meaningful way - and guess what? as that private business investment outside of the US grew and foreign investment into the US grew - the correlation between markets grew. not to sound glib but - duh.

that's not to say that foreign investments are unsound, or do not pay enough to assume the currency risk - i think that we have a bad tendency in this country to assume that the US dollar will always remain the world's standard - so foreign investment is attractive if there is more growth overseas, more value to be attained, and as a hedge against a weaker dollar. but as some kind of alchemy mix to hedge standard deviation of return - that's useless imho.

tr

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