Investment solution earns Nobel-level attention

Financial giant seeks rebalancing policy

State Street Associates (SSA) is an affiliate of State Street Corporation, a major global financial services company. SSA develops risk, investor behavior, and economic indicators as well as indices for clients around the world. SSA proposed that students in MIT Sloan's Proseminar in Capital Markets/Investment Management tackle a long-standing problem for investors: how best to determine a portfolio’s optimal rebalancing policy. Previously, investors had relied on ad hoc rules that yielded suboptimal results.

Published results intrigue Nobelist

The finance proseminar team came up with a dynamic programming solution that compared the transaction costs of rebalancing a portfolio to the certainty equivalent of preserving a suboptimal asset mix. The team’s faculty mentor was sufficiently impressed with their analysis that he encouraged them to write it up and submit it to a finance journal, which they did. After it was published, Harry Markowitz, a pioneer in the field of financial economics and a Nobel laureate, called the faculty to say that he had read their paper, which he liked very much. He correctly pointed out that their solution was not scalable, due to the curse of dimensionality*. Markowitz asked the faculty member to test a quadratic heuristic that he believed would overcome this phenomenon.The test showed that the heuristic did so, and the results were published in a finance journal.  Markowitz now lists among his achievements overcoming the curse of dimensionality, which he discusses in his most recent book.

Host gains profitable product

The host company developed a product based on the students’ and Markowitz’s insights, which they now distribute to institutional clients worldwide. In a nutshell, this project led to a student publication in a professional journal, which attracted the attention of a Nobel laureate, enabling him to claim credit for vanquishing a well-known phenomenon, and the sponsoring corporation developed an important and profitable  product.

*The curse of dimensionality refers to various phenomena that arise when analyzing and organizing data in high-dimensional spaces (often with hundreds or thousands of dimensions) that do not occur in low-dimensional settings such as the three-dimensional physical space of everyday experience.