Custom research paper on Modern Portfolio Theory

Modern portfolio theory represents principles underlying the analysis and evaluation of rational portfolio selection on the basis of compromise between risk and profitability and efficient diversification (Elton 2006: 9-11).
Modern portfolio theory provides an explanation of how the investor should form an investment portfolio in terms of efficient financial markets. The fundamental basis of this theory was laid in the 1950’s by H. Markowitz. The work of Markowitz was the transition from the consideration of profitability and risk of an individual asset to the consideration of profitability and risk of portfolio of assets. In addition, the theory formed the theoretical foundation for finding most effective portfolios (Wan 2000: 35-47).
Until 1950’s, the investment risk was determined only qualitatively, and there were no models, where the risk could be measured quantitatively. Markowitz supposed that investors would prefer those assets and portfolios, in which the possible deviation of return values from the expected value of return would be minimal. Markowitz first applied the statistical model of standard deviation in order to obtain quantitative measurement of risk, proceeding from the fact that investors were rational in their choice (Markowitz 1991: 146-159). This rationality can be described by the following examples: if there are two assets (portfolios) with the same risk, but different return, the investor chooses an asset (portfolio) with the highest returns; if there are two assets (portfolios) with different risk, but the same yield, the investor chooses an asset (portfolio) with the lowest risk (Benson 2008: 445 – 461). custom research paper
A significant contribution to the portfolio theory is made by J. Tobin, who determined the existence of an optimal portfolio for the investor among the set of efficient portfolios, and William F. Sharpe, who expanded Markowitz’s model by introducing risk-free asset. Sharpe showed that adding risk-free asset to the portfolio could improve its performance. He also concluded that one compound of optimal assets was predominant, regardless of the preferences of investors about risk/return relationship (Alexander 2009: 451-461).
In portfolio theory, the expected portfolio return means the weighted average expected values of yield of securities in the portfolio. The “weight” of each security is determined by the relative amount of money directed by investors for the purchase of these securities. Portfolio risk is explained not only through the individual risk of each individual security in portfolio, but also through the fact that there is a risk of impact of changes in observed annually values of yield per share on the return change of other shares included in portfolio (Ryals 2007: 991-1011; Xidonas 2009: 87-111).
Sharpe’s model is based on the method of linear regression analysis, which allows to link two variables – independent X and dependent Y- by a linear expression like Y=a + bX. In the model of Sharpe, an independent variable is the value of some market index (Chen, J 2004: 77-93). These may be, for example, growth rates of GDP, inflation rates, the price index of consumer goods, etc (Wan 2000: 115-121).
Thus, an efficient portfolio is a portfolio that provides minimal risk for a given value of the arithmetic level of profitability and maximal return at a given level of risk. The principles of forming efficient investment portfolio include: providing security (insurance against various risks and stability in income); achievement of returns acceptable for investors; liquidity provision; and achieving balance between profitability and risk, including diversification of the portfolio.