Ordinal Predictions and the Selection of Common Stocks

Abstract

Portfolio selection involves the formation of prior beliefs about expected rates of return and risk on available securities and the utilization of these beliefs in the choice of a portfolio. Markowitz has developed a pioneering theory of portfolio choice based on the assumption that the investor has formed prior cardinal beliefs about the expected rates of return, variances of rates of return, and covariances of rates of return among individual securities. Unfortunately, a feasible method of accurately generating the massive information requirements of the Markowitz model has not been developed. Historical measures of mean rates of, return and covariances of rates of return among individual securities have been shown to be unstable over time and to be ineffectual in generating ex ante efficient portfolios.