Nobels for nonsense

James Thompson, L. Baggett, William Wojciechowski and Edward Williams

Journal of Post Keynesian Economics, 2006, vol. 29, issue 1, 3-18

Abstract: We apply exploratory data analysis to some of the basic models of neoclassical computational finance. These include the portfolio selection algorithm of Markowitz, the capital market line of Sharpe, and the option pricing model of Black-Scholes-Merton. We demonstrate that the Markowitzian assumption of positive correlation of expected return and volatility is not supported by the data. The notion that an index fund based on market cap weighting is optimal is also shown to be inconsistent with market data. It is noted that the option pricing model of Black-Scholes-Merton is not supported by market history. The SIMUGRAM™, an empirical data-based paradigm for portfolio selection, is discussed. It is observed that some of the basic contemporary strategies of neoclassical computational finance may be seriously flawed and might profitably be replaced by data-based rules. We conclude that several Nobel Prizes in economics have been awarded for nonsense.

Date: 2006
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DOI: 10.2753/PKE0160-3477290101

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