Modern Portfolio Theory - MPT

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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

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    Covariance indicates the relationship of two variables whenever one variable changes. If an increase in one variable results ... Read Full Answer >>
  2. 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 >>
  3. 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 >>
  4. 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 >>
  5. 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 >>
  6. 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 >>
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