After several decades of economic breakthroughs, the science of investing was recognized in 1990. The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, commonly know as the Nobel Prize in Economic Sciences, was awarded to three investment research pioneers for their collective work known as Modern Portfolio Theory: Harry Markowitz, for research regarding portfolio construction in relation to risk and return; William Sharpe, for his Capital Asset Pricing Model and the concept of beta; and Merton Miller, for modern corporate finance theory and the theory of company valuation with respect to dividends. After years of work, they were credited with collectively reforming the way the world invests and forming conclusions that continue to inspire financial economists today.
Harry Markowitz
When Markowitz was a doctoral student at the University of Chicago in 1952, he concluded that investment diversification reduced risk. His groundbreaking paper, "Portfolio Selection,"1 is the foundation of Modern Portfolio Theory. In fact, he is commonly referred to as the "Father of Modern Portfolio Theory." Markowitz's contributions showed that assets should be evaluated not only for their individual characteristics, but also for their combined effect on a portfolio as a whole. His research mathematically supports efficient portfolios that have provided the highest expected return for a given level of risk.
William Sharpe
Stanford professor William Sharpe presented the Capital Asset Pricing Model (CAPM), or single factor asset-pricing model, in his 1963 paper, "A Simplified Model for Portfolio Analysis."2 In his 1964 paper, "Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk,"3 he theorized risk is volatile relative to the market and found an asset's sensitivity to market risk (known as beta) determines an investor's expected return and the cost of capital of a firm. Stocks that carry higher risk (a beta greater than one) are more volatile than the market and therefore should have higher expected returns. CAPM is often used as the asset-pricing model for evaluating the risk and expected return of securities and portfolios.
Merton Miller
Merton Miller derived two vital invariance theorems with the help of Franco Modigliani, now aptly named the Modigliani-Miller or MM theorems. Through Miller's work, an important lesson was ascertained: a firm's value is unrelated to its dividend policy, and dividend policy is an unreliable guide for stock selection. The MM theorems have since established themselves as the comparative norm for theoretical and empirical analyses in corporate finance.