Definition
Modern Portfolio Theory, developed by Harry Markowitz, demonstrates that diversification can reduce portfolio risk without sacrificing returns. It uses statistical measures (expected return, variance, correlation) to construct optimal portfolios. MPT shows that the risk of a portfolio is less than the weighted average of individual asset risks.
Formula
Portfolio Variance = ΣΣwᵢwⱼCov(rᵢ,rⱼ)
Example
MPT shows combining stocks with 0.3 correlation creates a portfolio with less risk than either stock alone.
FAQ
What is Modern Portfolio Theory (MPT)?
A framework for constructing portfolios to maximize return for a given risk level.
How do you calculate Modern Portfolio Theory (MPT)?
A common formula for Modern Portfolio Theory (MPT) is: Portfolio Variance = ΣΣwᵢwⱼCov(rᵢ,rⱼ)
Why is Modern Portfolio Theory (MPT) important?
Modern Portfolio Theory (MPT) helps investors evaluate portfolio management and make more informed decisions.