Modern Portfolio Theory
The second basic component of Free Market Portfolio Theory is Modern Portfolio Theory, which earned the Nobel Prize in Economics in 1990 for the collaborative work of Harry Markowitz, Merton Miller and Myron Scholes.
- The risk of an individual asset is far less important than the contribution the asset makes to the portfolio’s risk as a whole.
- For the same amount of risk, diversification can increase returns.
- The mechanism to reduce risk is dissimilar price movements; therefore, the task is to find assets with low correlations.
- The Efficient Frontier allows individuals to maximize expected returns for any level of volatility.