A theoretical framework for analyzing investment portfolios based on their expected return and risk.
Introduction
Modern portfolio theory (MPT) is a framework for analyzing portfolios of investments. The concept is based on the premise that the investor is risk averse and there are only two factors differentiating between potential portfolios - expected return and risk. Thus the investor can optimize his investment decision by choosing a combination of assets that maximize the portfolio's expected return for a given amount of risk or vice versa minimize risk for a given level of expected return.
As the standard deviation of return is the most common proxy for risk, quite often MPT application can also be referred to as mean-variance analysis or mean-variance optimization (MVO).
Further resources:
- Modern portfolio theory at Wikipedia
- Markowitz, H.: Portfolio Selection. The Journal of Finance, 7 (1): 77–91, 1952.
