Behavioral economics has recently been challenging the basic assumptions of the modern portfolio theory. There are people who understand modern portfolio theory as a mathematical formulation. The formulation mainly focuses on how investments can be diversified. Under this criterion, investments that are grouped together are put together and it is believed that they have a lower risk value when compared to individual assets.Before Markowitz’s work, many investors mainly kept their focus on risk assessment and security of rewards so that they could construct their portfolios. This was referred to as standard investment and this was mainly used to offer the best securities that offered the best opportunities. It was Markowitz who formalized the standard investment theory by coming up with the modern portfolio theory. He modernized it by using the mathematics of diversification. He used this by advising investors to compile their portfolios and chose those with reward characteristics. What he was trying to propose ways that they should not choose individual securities but portfolios.When a single-period return is treated as a variable that is random for the securities, expected values, correlations, and expected values can be assigned to them. When one does this, then they are able to calculate the expected volatility and the expected return (Becker, 2005 pg. 90 ). This calculation can be done for any constructed portfolios with their securities. Expected returns and volatility, in this case, can be treated as proxies for rewards and risks. One way or another risk and reward could optimally balance each other out. Markowitz referred this to as efficient frontiers for the various portfolios.Portfolio theory is an approach that was developed by Markowitz. In his approach, he postulated that investors could predict how they can be able to predict and estimate both returns and risks. This usually measured statistically for any investment portfolio.
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