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    • Home
    • Request Info
    • The Numbers
    • Risk Adjusted Ratios
    • Make an Appointment
    • Modern Portfolio Theory
    • Learn How to use Algos
    • Privacy Policy
  • Home
  • Request Info
  • The Numbers
  • Risk Adjusted Ratios
  • Make an Appointment
  • Modern Portfolio Theory
  • Learn How to use Algos
  • Privacy Policy

Modern Portfolio Theory

What is the Modern Portfolio Theory and how can i use it?

  

Modern portfolio theory (MPT), or mean-variance analysis, is a mathematical framework for assembling a portfolio of assets such that the expected return is maximized for a given level of risk. It is a formalization and extension of diversification in investing, the idea that owning different kinds of financial assets is less risky than owning only one type. Its key insight is that an asset's risk and return should not be assessed by itself, but by how it contributes to a portfolio's overall risk and return. It uses the variance of asset prices as a proxy for risk.[1]

Economist Harry Markowitz introduced MPT in a 1952 essay,[2] for which he was later awarded a Nobel Prize in Economics.


 

Mathematical model

Risk and expected return 


MPT assumes that investors are risk averse, meaning that given two portfolios that offer the same expected return, investors will prefer the less risky one. Thus, an investor will take on increased risk only if compensated by higher expected returns. Conversely, an investor who wants higher expected returns must accept more risk. The exact trade-off will be the same for all investors, but different investors will evaluate the trade-off differently based on individual risk aversion characteristics. The implication is that a rational investor will not invest in a portfolio if a second portfolio exists with a more favorable risk-expected return profile – i.e., if for that level of risk an alternative portfolio exists that has better expected returns.

Under the model:

  • Portfolio return is the proportion-weighted combination of the constituent assets' returns.
  • Portfolio volatility is a function of the correlations ρij of the component assets, for all asset pairs (i, j).


 


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  1. Copyright © 2018 SuccessfulTradingSystems.com - All Rights Reserved.   Copyright © 2018 SuccessfulTradingSystems.com - All Rights Reserved.  THIS BRIEF STATEMENT CANNOT, OF COURSE, DISCLOSE ALL THE RISKS AND OTHER ASPECTS OF THE COMMODITY MARKETS HYPOTHETICAL RESULTS:These results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under-or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown. Futures trading carries risk and is not suitable for all investors.
     


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