Modern Portfolio Theory (MPT)
Modern Portfolio Theory (MPT) is an investment theory developed by Nobel Laureate Harry Markowitz in 1952. It is based on the idea that investors should diversify their investments in order to reduce risk and maximize returns. MPT states that investors should create portfolios that are diversified across different asset classes and that have a low correlation with each other. This diversification allows investors to reduce their overall risk while still achieving a higher return than if they had invested in a single asset class.
History of Modern Portfolio Theory
Modern Portfolio Theory was first proposed by Harry Markowitz in 1952. Markowitz was a professor at the University of Chicago and his work was based on the idea that investors should diversify their investments in order to reduce risk and maximize returns. He proposed that investors should create portfolios that are diversified across different asset classes and that have a low correlation with each other. This diversification allows investors to reduce their overall risk while still achieving a higher return than if they had invested in a single asset class.
Markowitz’s work was further developed by other economists such as William Sharpe, John Lintner, and Jan Mossin. These economists developed the Capital Asset Pricing Model (CAPM) which is used to calculate the expected return of an investment based on its risk. The CAPM is still used today by investors and financial advisors to determine the optimal portfolio for a given investor.
Table of Comparisons
| Investment Strategy | Risk | Return |
|---|---|---|
| Modern Portfolio Theory | Low | High |
| Single Asset Class | High | Low |
Summary
Modern Portfolio Theory (MPT) is an investment theory developed by Nobel Laureate Harry Markowitz in 1952. It is based on the idea that investors should diversify their investments in order to reduce risk and maximize returns. MPT states that investors should create portfolios that are diversified across different asset classes and that have a low correlation with each other. This diversification allows investors to reduce their overall risk while still achieving a higher return than if they had invested in a single asset class. For more information about Modern Portfolio Theory, please visit Investopedia, The Balance, and Morningstar.
See Also
- Capital Asset Pricing Model (CAPM)
- Risk-Return Tradeoff
- Diversification
- Asset Allocation
- Portfolio Optimization
- Sharpe Ratio
- Beta
- Alpha
- Value at Risk (VaR)
- Expected Shortfall (ES)
