Harry Markowitz’s contributions to utility theory

Abstract

Harry Markowitz is widely recognized to be the father of portfolio theory. But, for unknown reasons, his substantial contributions to utility theory are less well-known. Daniel Bernoulli is widely renowned for explaining the Saint Petersburg paradox. Most people recognize Adam Smith as being the father of capitalism. Some people are aware that Carl Menger (1840–1921) was one of the first to discuss (in German) diminishing marginal utility. Jules Dupuit (1804–1866) distinguished between total utility and marginal utility and, in the process, he went on to discover the consumers’ surplus. Although it is not widely recognized, Herman Heinrich Gossen (1810–1858) was the first economists to explain that the fundamental principle of marginal utility theory is that a person maximizes his utility when he distributes his available money among the various goods so that he obtains the same amount of satisfaction from the last unit of money spent on each different commodity. After explaining the Saint Petersburg paradox earlier in his career comma, Daniel Bernoulli later brought many utility suggestions together into one tidy package, and even went on to suggest that decision-maker’s decisions can probably be best represented by the logarithmic utility function. Each one of the previous contributions to utility theory constitutes a significant improvement in the previous theory. But in 1952 Harry Markowitz published several suggestions that each represented a significant advancement to the existing utility theory. The value of Markowitz’s suggestions was acknowledged in 1979 and 1992 by two psychologists named Daniel Kahneman and Amos Tversky when they introduced their prospect theory. These co-authors list and discuss several of Markowitz’s contributions to expected utility theory in their 1979 prospect theory paper.