Please use this identifier to cite or link to this item: http://hdl.handle.net/1946/7233
Modern Portfolio Theory: Does it work?
The main objective of this paper is to discuss and test some of the fundamental elements of the Modern Portfolio Theory in an effort to establish whether the optimal portfolios based on the theory provide the best asset allocation strategies in the real investment world. To answer this question, three of the fundamental elements of the theory are tested statistically. Furthermore, a portfolio is constructed using three different types of models based on the theory and the outcome discussed and evaluated.
The empirical results show that two of the three elements of the theory which were tested did not hold up to statistical tests. The efficiency of the market was the only statistically tested element that held up to the tests. The construction of portfolios showed that the models were inconsistent and one of the models, the efficient portfolio, showed very unrealistic positions. These results led to the conclusion that optimal portfolios based on Modern Portfolio Theory are not the best asset allocation strategies in the real investment world. At the same time, however, it is concluded that despite its flaws the theory is still the only properly formed and implemented theory for portfolio construction.