What is Modern Portfolio Theory?

Modern Portfolio Theory (MPT) is also called modern portfolio theory, portfolio theory or investment diversification theory.

Modern portfolio theory

Modern portfolio theory was proposed by Markowitz, a professor of economics at the Baruch School of the City University of New York.

3In March 1952, Markowitz published a paper entitled "Selection of Asset Portfolio" in the Journal of Finance.

1. Dispersion principle

Generally speaking, investors

The theory of modern asset portfolio is mainly aimed at the possibility of solving investment risks. The theory holds that some risks are not related to other securities, and diversifying investment objects can reduce individual risks (unique risk or unsystematic risk), so the information of individual companies becomes less important. Individual risks are market risks, and there are generally two types of market risks: individual risks and systematic risks. The former refers to the risks surrounding individual companies and the uncertainty of the return on investment of a single company; the latter refers to the entire economy. The resulting risks cannot be mitigated by diversification.

Although diversified investments can reduce individual risks, first of all, some risks are related to the risks of other or all securities. When the risks affect all securities in the market in a similar way, all securities will react similarly, so The portfolio of securities cannot avoid the risks of the entire system.

Secondly, even diversified investments may not necessarily be invested in the stocks of several different companies, but may be scattered in many aspects such as stocks, bonds, and real estate.

Again, not every investor may adopt a diversified investment approach. Therefore, risk diversification is not always completely effective in practice.

This theory mainly solves the problem of how investors measure different investment risks and how to reasonably combine their own funds to obtain maximum returns. The theory holds that there is a certain special relationship between the investment risks and returns of portfolio financial assets, and the dispersion of investment risks is regular.

Assuming the market is efficient, investors will be able to learn about various changes in returns and risks in the financial market and their causes.

Assume that investors are risk averse and are willing to get higher returns. If they are to bear greater risks, they must be compensated by getting higher expected returns. Risk is measured by the variability of the rate of return and is represented by the statistical standard deviation.

Assume that investors choose a portfolio based on the expected return and standard deviation of the financial assets, and that the portfolio they choose has a higher rate of return or a lower risk.

Assume that the returns between multiple financial assets are related. If the correlation coefficient between each financial asset is known, it is possible to choose the investment portfolio with the lowest risk.