Modern portfolio theory


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Modern portfolio theory

Principals underlying the analysis and evaluation of rational portfolio choices based on risk return trade-offs and efficient diversification.

Modern Portfolio Theory

A theory of investing stating that every rational investor, at a given level of risk, will accept only the largest expected return. More specifically, modern portfolio theory attempts to account for risk and expected return mathematically to help the investor find a portfolio with the maximum return for the minimum about of risk. A Markowitz efficient portfolio represents just that: the most expected return at a given amount of risk (sometimes excluding zero risk). Harry Markowitz first began developing this theory in an article published in 1952 and received the Nobel prize for economics for his work in 1990. See also: Homogenous expectations assumption, Markowitz efficient set of portfolios.

modern portfolio theory

Modern portfolio theory.

In making investment decisions, adherents of modern portfolio theory focus on potential return in relation to potential risk.

The strategy is to evaluate and select individual securities as part of an overall portfolio rather than solely for their own strengths or weaknesses as an investment.

Asset allocation is a primary tactic according to theory practitioners. That's because it allows investors to create portfolios to get the strongest possible return without assuming a greater level of risk than they are comfortable with.

Another tenet of portfolio theory is that investors must be rewarded, in terms of realizing a greater return, for assuming greater risk. Otherwise, there would be little motivation to make investments that might result in a loss of principal.

References in periodicals archive ?
The first four chapters are devoted to a description of Modern Portfolio Theory, Efficient Market Hypothesis and Expected Utility Theory and their flaws.
A rigorous application of Modern Portfolio Theory will distinguish among kinds of stocks (large cap/small cap; value/momentum; sector), kinds of bonds (high grade/high yield; sovereign/corporate), and both across currencies.
With the arrival of the Prudent Investor Rule[1] and the development of the modern portfolio theory,[2] trustees now have great flexibility to invest aggressively and to improve the total return for both income beneficiaries and remaindermen.
Modern portfolio theory would suggest that the answer is a resounding "yes.
Under modern portfolio theory, an appropriate asset allocation is fundamental to effective and profitable investment management; using a mutual fund family to accomplish this makes sense.
The new law is based on the Modern Portfolio Theory.
The purpose of this article is to review the basic tenets of modern portfolio theory and to show how the addition of new asset classes, even those which are riskier in and of themselves, to an existing portfolio may provide incremental returns without incurring additional risk.
The key to modern portfolio theory is a mathematical model.
23 Modern portfolio theory for real estate securities portfolios
In addition, Jeff will provide his thoughts on how the modern portfolio theory is no "longer modern," and discuss asset allocation issues and the Endowment Model.
Liquid's investment process is driven by 'Liquid Investment Theory' (LIT), a refinement of Modern Portfolio Theory, itself used in one form or another by all fundamentally driven investors.
As more service providers saw the lucrative advantages of entering the 401(k) market, Modern Portfolio Theory descended upon the retirement plan world like a dark cloud.