FANDOM


Navigate: Investment Theories ... Investment Strategies ... Trading Rules... (edit)


Overview


Modern portfolio theory (MPT) is a theory of investment which tries to maximize return and minimize risk by carefully choosing differentassets. Although MPT is widely used in practice in the financial industry and several of its creators won a Nobel prize for the theory, in recent years the basic assumptions of MPT have been widely challenged by fields such as behavioral economics, and many companies using variants of MPT have gone bankrupt in various financial crises.[1]
MPT is a mathematical formulation of the concept of diversification in investing, with the aim of selecting a collection of investment assets that has collectively lower risk than any individual asset. This is possible, in theory, because different types of assets often change in value in opposite ways. For example, when the prices in the stock market fall, the prices in the bond market often increase, and vice versa. A collection of both types of assets can therefore have lower overall risk than either individually.
More technically, MPT models an asset's return as a normally distributed random variable, defines risk as the standard deviation of return, and models a portfolio as a weighted combination of assets so that the return of a portfolio is the weighted combination of the assets' returns. By combining different assets whose returns are not correlated, MPT seeks to reduce the total variance of the portfolio. MPT also assumes that investors are rational and markets are efficient.
MPT was developed in the 1950s through the early 1970s and was considered an important advance in the mathematical modeling of finance. Since then, much theoretical and practical criticism has been leveled against it. These include the fact that financial returns do not follow a Gaussian distribution and that correlations between asset classes are not fixed but can vary depending on external events (especially in crises). Further, there is growing evidence that investors are not rational and markets are not efficient.
Perhaps the most spectacular example of MPT's shortcomings was the failure of Long Term Capital Management in 1998.

Share!

Share and tell about your experience related to Markowitz Portfolio Selection Theory in our wiki-based forum.


Concept

zaxa

Plus Points

Markowitz Portfolio Selection Theory (plus points)

Minus Points

Markowitz Portfolio Selection Theory (minus points)

Quotations

Markowitz Portfolio Selection Theory (quotations)

User Reviews are most Welcome!

Markowitz Portfolio Selection Theory (reviews)

Everything else

Got something to say that doesn't fit in the other sections of this page?
Create a new page about it: Markowitz Portfolio Selection Theory (miscellaneous)


External resources

If you want to add personal links, please do that on your user page (you can also write your profile there). If you have a link with great content related to this wiki, you can add it at Markowitz Portfolio Selection Theory (links)

This Finance Wikia Page is just an Outline Page and requires more content. Please help in anyway you may wish to make this page grow! Thanks.
Community content is available under CC-BY-SA unless otherwise noted.