What are the two ways in which the Markowitz mean-variance framework has been used by investors?

Question

What will be an ideal response?

Answer 1

The Markowitz mean-variance framework has been applied to portfolio construction in two ways. The first is at the asset class level where investors make an asset allocation decision. This is the decision as to how to allocate funds amongst the major asset classes (stocks, bonds, cash, real estate, and alternative assets). This has probably been the major use of the Markowitz framework.

The second application is the use of the mean-variance framework to select securities to construct portfolio. Although the mean-variance framework has been used in equity portfolio management for a good number of years, it has seen very limited use in bond portfolio.Moving from the implementation for constructing portfolios within an asset class requires the estimation of the inputs (mean, variance, and covariance) for all of the securities that are candidates for inclusion in the portfolio. These inputs are not easily estimated and there is an entire literature dealing with the issues associated with estimation risk.