A Comprehensive Analysis of The Modern Portfolio Theory

Abstract

The emergence of the modern portfolio theory in 1952 marked the beginning of a new era in portfolio management. In addition to the con pets forwarded by active and passive portfolio theory, the MPT (modern portfolio theory) outlines the importance of diversification in reducing the risk associated with a portfolio, which is achieved thanks to the credentials of diversification in eliminating specific risk. The importance of contemplating assets as parts of a portfolio instead of individual investments, thus putting the criteria of low risk before high return is also a fundamental concept presented by MPT. This results in changes in investors’ behavior, more particularly in the way they evaluate assets and contemplate the financial market. However, despite its extensive use and recognition, the MPT still has alarming pitfalls due to the unrealistic character of its assumptions and its neglect of macroeconomic factors as well as the possible evolution of the companies. This essay will first present the evolution of MPT, its use, its influence on investors’ behavior as well as its limits.