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.
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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.
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modern portfolio theory

Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott. Copyright © 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved. All rights reserved.

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.

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References in periodicals archive ?
The portfolio optimization by the Markowitz model was performed by the Solver function of the Excel software, based on the long-term interest rate of the following countries: the United States, Japan, Germany, France, Australia, Canada, and Great Britain.
A third reason we have favored small portfolios is that some of the modifications to the original Markowitz model create more problems than they seem to solve, for instance, the presence of a risk-free rate that in reality is stochastic or customary inclusion of textbook (naive) short sales that violate Federal Reserve regulations and make little economic sense.
The Markowitz model assumes that investors would like to maximize return under a certain risk level or minimize the risk with a certain return level [6] and this model makes use of the mean and variance of normalized historical asset prices to compute the expected portfolio return and risk [24], respectively.
Determining the optimized portfolio based on Markowitz model has a lot of complications including the volume of the calculation and the number of variables so that in a market with N investors, [n.sup.2] + 3n + 2/2 variable should be calculated.
However, the impact of adding CVaR constraint to the Markowitz model on the portfolios with low benefit payment ratio is not as significant as that on the relatively high benefit payment ratio portfolios.
In an analogy with the Markowitz model, where investors minimize portfolio variance for a given level of expected return, I consider a regional economic activity characterized by some return (its overall value added growth rate), uncertainty (sector growth rate variability), and portfolio structure (sector composition of economic activity).
Markowitz (1952) proposed the mean-variance (MV) or Markowitz model by using variance as the measure of risk while mean return as the expected return.
Sharpe (1964), Lintner (1965), Mossin (1966) and others have utilized the choice-theoretic structure of the Markowitz model as the basis for a positive theory of equilibrium capital asset pricing under conditions of uncertainty.
The Markowitz model is a relatively simple nonlinear programming model designed to maximize wealth over a single time horizon.
The Sharpe Model for an individual security can be employed to construct a model alternative to the Markowitz Model of portfolio.
The Markowitz model assumes that for any given rate of growth there is a minimum level of volatility, and for any given level of volatility, there is a maximum rate of growth.