Modern Portfolio Theory - MPT

AAA

DEFINITION of 'Modern Portfolio Theory - MPT'

A theory on how risk-averse investors can construct portfolios to optimize or maximize expected return based on a given level of market risk, emphasizing that risk is an inherent part of higher reward.

Also called "portfolio theory" or "portfolio management theory."

INVESTOPEDIA EXPLAINS 'Modern Portfolio Theory - MPT'

According to the theory, it's possible to construct an "efficient frontier" of optimal portfolios offering the maximum possible expected return for a given level of risk. This theory was pioneered by Harry Markowitz in his paper "Portfolio Selection," published in 1952 by the Journal of Finance.

There are four basic steps involved in portfolio construction:
-Security valuation
-Asset allocation
-Portfolio optimization
-Performance measurement

RELATED TERMS
  1. Portfolio Variance

    The measurement of how the actual returns of a group of securities ...
  2. Permanent Portfolio

    A portfolio construction theory devised by free-market investment ...
  3. Harry Markowitz

    A Nobel Memorial Prize winning economist who devised the modern ...
  4. Treynor-Black Model

    A type of asset allocation model that was developed by Jack Treynor ...
  5. The Kelly Criterion

    A mathematical formula relating to the long-term growth of capital ...
  6. Optimization

    In the context of technical analysis, it is the process of adjusting ...
RELATED FAQS
  1. How is correlation used in modern portfolio theory?

    Modern portfolio theory (MPT) emphasizes that investors can diversify away the risk of investment loss by reducing the correlation ... Read Full Answer >>
  2. Is alpha the best risk measure?

    There are many different types of risk associated with investing, and it is almost impossible for any single technical indicator ... Read Full Answer >>
Related Articles
  1. Investing Basics

    Achieving Optimal Asset Allocation

    Minimizing risk while maximizing return is any investor's prime goal. The right mix of securities is the key to achieving your optimal asset allocation.
  2. Options & Futures

    How Risk Free Is The Risk-Free Rate Of Return?

    This rate is rarely questioned - unless the economy falls into disarray.
  3. Mutual Funds & ETFs

    Protect Your Foreign Investments From Currency Risk

    Hedging against currency risk can add a level of safety to your offshore investments.
  4. Professionals

    The Workings Of Equity Portfolio Management

    Achieve analytical efficiency by applying your evaluation to a key set of stocks.
  5. Mutual Funds & ETFs

    How To Pump Up Your Portfolio With ETFs

    These funds trade like stocks, provide diversification, reduce risk and increase returns.
  6. Mutual Funds & ETFs

    Strategies For Determining The Market's True Worth

    Learn the strengths and weaknesses of passive and active management when trying to uncover the overall market's worth.
  7. Forex Education

    Improve Your Investing With Excel

    Excel is a useful tool to assist with investment organization and evaluation. Find out how to use it.
  8. Insurance

    The Dangers Of Over-Diversifying Your Portfolio

    If you diversify too much, you might not lose much, but you won't gain much either.
  9. Active Trading

    Modern Portfolio Theory: Why It's Still Hip

    See why investors today still follow this old set of principles that reduce risk and increase returns through diversification.
  10. Mutual Funds & ETFs

    Permanent Portfolio Locks In Long-Term Profits

    Harry Browne believes his "permanent portfolio" theory is the ideal long-term investing strategy.

You May Also Like

Hot Definitions
  1. Income Effect

    In the context of economic theory, the income effect is the change in an individual's or economy's income and how that change ...
  2. Price-To-Sales Ratio - PSR

    A valuation ratio that compares a company’s stock price to its revenues. The price-to-sales ratio is an indicator of the ...
  3. Hurdle Rate

    The minimum rate of return on a project or investment required by a manager or investor. In order to compensate for risk, ...
  4. Market Value

    The price an asset would fetch in the marketplace. Market value is also commonly used to refer to the market capitalization ...
  5. Preference Shares

    Company stock with dividends that are paid to shareholders before common stock dividends are paid out. In the event of a ...
  6. Accrued Interest

    1. A term used to describe an accrual accounting method when interest that is either payable or receivable has been recognized, ...
Trading Center