Do you agree with Modern Portfolio Theory?

[phk]

Do you agree with Modern Portfolio Theory?



Modern portfolio theory (MPT) proposes how rational investors will use diversification to optimize their portfolios, and how a risky asset should be priced.

The basic concepts of the theory are:

*Markowitz diversification
*Risk/Return tradeoff
*The efficient frontier
*Capital asset pricing model
*The Alpha and Beta(β) coefficients

Alpha is a risk-adjusted measure of the so-called active return on an investment. It is the return in excess of the compensation for the risk borne, and thus commonly used to assess active managers' performances.

    * αi < rf: the investment has earned too little for its risk (or, was too risky for the return)
    * αi = rf: the investment has earned a return adequate for the risk taken
    * αi > rf: the investment has a return in excess of the reward for the assumed risk

In finance, the beta (β) of a stock or portfolio is a number describing the relation of its returns with that of the financial market as a whole.

*the Capital Market Line
*Securities Market Line.

MPT models an asset's return as a random variable, and models a portfolio as a weighted combination of assets so that the return of a portfolio is the weighted combination of the assets' returns. Moreover, a portfolio's return is a random variable, and consequently has an expected value and a variance. Risk, in this model, is the standard deviation of return.

[k-onmmunist]

I'm going to say yes.

[phk]

I suppose its a fairly good theoretical model (it's greatest breakthrough was quantifying risk as the standard deviation of asset returns through various portfolios on a risk-return frontier) and for which Harry Markowitz won the Nobel Prize. 

[phk]

Chance a U.S. household that owns a Prius also owns an SUV: 1 in 3.
That is from Harper's Index, October issue.

This is cool. Portfolio theory extrapolated into horsepower and miles per gallon (as a tradeoff and graphed in the appropriate frontier).

Maybe the RF could be seen as the minimum miles per gallon with indifference curves representing optimal "portfolios" of cars.