Markowitz theory of asset allocation is one of very few research ideas that made it into practical finance. Yet, its investment recommendations exhibit incredible sensitivity to even smallest variations in the estimation horizon or estimation techniques. Scientists as well as practitioners have put enormous effort into stabilizing the estimators of portfolios (with moderate success, according to some). However, there seems to be no simple quantitative method to measure the portfolio stability. In this talk, I will derive
analytical formulas that relate the mean and the covariance matrix of asset returns with the stability of portfolio composition. These formulas allow for the indentification of main culprits of worse-than-expected performance of the Markowitz framework. In particular, I will question the common wisdom that puts the main responsibility on estimation errors of the mean.

This research is a spin-off of a consultancy project at the University of Warsaw regarding the allocation of the foreign reserves of Polish Central Bank.