Modern Portfolio Theory - MPT


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."


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BREAKING DOWN '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

  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. Efficient Frontier

    A set of optimal portfolios that offers the highest expected ...
  4. Harry Markowitz

    A Nobel Memorial Prize winning economist who devised the modern ...
  5. Covariance

    A measure of the degree to which returns on two risky assets ...
  6. Optimization

    In the context of technical analysis, it is the process of adjusting ...
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  1. What types of assets lower portfolio variance?

    Assets that have a negative correlation with each other reduce portfolio variance. Variance is one measure of the volatility ... Read Full Answer >>
  2. How is portfolio variance reduced in Modern Portfolio Theory?

    According to modern portfolio theory, or MPT, portfolio variance can be reduced by diversifying a portfolio through the inclusion ... Read Full Answer >>
  3. Why is risk return tradeoff important in designing a portfolio?

    The risk-return tradeoff determines how aggressive an investor wants to be with the assets included in the portfolio. An ... Read Full Answer >>
  4. How reliable is the mean variance analysis of an investment?

    Mean variance analysis of an individual investment or asset can provide a historical measure of volatility for the investment. ... Read Full Answer >>
  5. Can a mean variance analysis be done for any investment?

    A mean variance analysis is performed on a group of assets in a portfolio across a certain time horizon. This analysis can ... Read Full Answer >>
  6. How do investment advisors calculate how much diversification their portfolios need?

    One effective tool for investment advisers to determine the amount of diversification necessary for a portfolio is modern ... Read Full Answer >>
  7. What are some of the uses of the coefficient of variation (COV)?

    In statistics, the coefficient of variation (COV) is a simple measure of relative event dispersion. It is equal to the ratio ... Read Full Answer >>
  8. How do you interpret the magnitude of the covariance between two variables?

    Covariance indicates the relationship of two variables whenever one variable changes. If an increase in one variable results ... Read Full Answer >>
  9. How is covariance used in portfolio theory?

    Covariance is used in portfolio theory to determine what assets to include in the portfolio. Covariance is a statistical ... Read Full Answer >>
  10. Where did Modern Portfolio Theory (MPT) come from?

    Modern portfolio theory, or MPT, came from Harry Markowitz and was first introduced in a paper titled "Portfolio Selection" ... Read Full Answer >>
  11. Is there a positive correlation between risk and return?

    There is a positive correlation between risk and return with one important caveat. There is no guarantee that taking greater ... Read Full Answer >>
  12. How does covariance impact portfolio risk and return?

    Covariance provides diversification and reduces the overall volatility for a portfolio. Covariance is a statistical measure ... Read Full Answer >>
  13. 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 >>
  14. 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 >>

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