Markowitz Revisited: Addressing Ambiguity as an Important Parameter in Portfolio Optimization

Since 1952, when the mean-variance model of Markowitz introduced as a basic framework for modern portfolio theory, some researchers have been trying to add new dimensions to this model. However, most of them have neglected the nature of decision making in such situations and have focused only on adding non-fundamental and thematic dimensions such as considering social responsibilities and green industries. Due to the nature of stock market, the decisions made in this sector are influenced by two different parameters: (1) analyzing past trends and (2) predicting future developments. The former is derived objectively based on historical data that is available to everyone while the latter is achieved subjectively based on inside-information that is only available to the investor. Naturally, due to differences in the origin of their creation the bridge between these two types of analysis in order to optimize the portfolio will be a phenomenon called "ambiguity". Hence, in this paper, we revisited Markowitz's model and proposed a modification that allow incorporating not only return and risk but also incorporate ambiguity into the investment decision making process. Finally, in order to demonstrate how the proposed model can be applied in practice, it is implemented in Tehran Stock Exchange (TSE) and the experimental results are examined. From the experimental results, we can extract that the proposed model is more comprehensive than Markowitz's model and has greater ability to cover the conditions of the stock market.