Modern Portfolio Theory describes how asset classes can be combined into diversified asset mixes. In March 1952 Harry Markowitz published the landmark article titled “Portfolio Selection,” in the Journal of Finance, which first described the efficient frontier. He was subsequently awarded the Nobel Prize in Economics for this concept.
Modern Portfolio Theory assumes that:
- Investors are rational and act to maximize the performance of their blue chip stocks investments given their risk tolerance.
- Investors choose portfolios according to the expected return and risk characteristics.
- Rational investors prefer less risk and more return.
- Expected return is defined as the total return including income plus capital appreciation.
- Risk is defined an uncertainty. It is an estimate of the possible variability around the expected return. The statistical measure of risk that is commonly used is standard deviation.