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 modern portfolio theory introduced by Markowitz (1952) was later developed and refined by Markowitz (1959).
To build an EF and the corresponding CML is a natural step after studying modern portfolio theory. However, few studies exist on the application of the theory to concrete capital markets.
Modern portfolio theory (MPT), efficient market hypothesis (EMH) and Rational Hypothesis are considered as the foundation of traditional theories.
(1.) "With the advent of Modern Portfolio Theory in the 1950s and its subsequent adoption by institutional investors from the 1960s to 1980s, commercial real estate went from cottage industry to bona fide asset class.
The main objective of this paper is to analyze whether listed real estate securities distinctive features can characterize Brazilian REITs as an alternative investment despite exposure to real estate, stock or bonds markets, considering the Modern Portfolio Theory approach.
The models chosen fall within Modern Portfolio Theory (MPT) and Behavioural Portfolio Theory (BPT).
Woodall further opined in the report that this approach of portfolio protection is vastly different from the Modern Portfolio Theory approach of using bonds to offset stocks during times of sudden market changes but is definitely proving to be more effective in recent times.
Portfolio management saw increased application in multiple private--and public-sector industries (Donaldson 2000; ISACA 2012; Kumar, Ajjan, and Niu 2008; Miljkovic 2006; Project Management Institute 2008; Rad and Levin 2006; Reginato 2005) after the 1990 Nobel Prize in Economics was awarded to Harry Markowitz for his 1952 portfolio management theory (Modern Portfolio Theory 2009.) While commonly associated with financial portfolios, the theoretical application of portfolio management is increasingly being applied to other portfolios of organizational resources, such as portfolios of projects, new product developments, and research investments (Hossenlopp 2010; Kumar, Ajjan, and Niu 2008).
That's important, because the Employee Retirement Income Security Act (ERISA)'s investment rules are based on generally accepted investment theories, such as modern portfolio theory (MPT).
"RISK AND RETURN ARE RELATED." That was the soundbite of the 20th century, the mantra of Modern Portfolio Theory. Whether through those ubiquitous risk tolerance questionnaires or nearly any portfolio optimization software package, in one way or another, most professionals have been trained to use the mathematical equivalent of risk to plot investment strategies.
In the mid-20th century, the concept of modern portfolio theory took precedence.
Modern Portfolio Theory and Investment Analysis, 9th Edition