Modern Portfolio Theory (MPT)
MPT, developed by Harry Markowitz (Nobel 1990), is a mathematical framework for assembling portfolios to maximize expected return for a given risk level.
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Definition
MPT, developed by Harry Markowitz (Nobel 1990), is a mathematical framework for assembling portfolios to maximize expected return for a given risk level.
Use case
Used in portfolio management workflows, analysis, and technical interviews.
Judgment check
Useful only when the assumptions and inputs behind the metric are understood.
Deep dive
How to think about Modern Portfolio Theory (MPT)
MPT introduces the efficient frontier — portfolios offering highest return per unit of risk. Key insights: (1) Diversification reduces risk without sacrificing return, (2) Risk should be measured by portfolio (not individual security) variance, (3) Correlation between assets matters more than individual risks. Foundation of passive investing and portfolio construction.
Example: Using MPT optimization, a portfolio combining 60% stocks (10% return, 15% volatility) and 40% bonds (4% return, 5% volatility) with 0.2 correlation achieves 7.6% expected return with only 9.5% volatility — better risk-adjusted return than either asset alone.