APPLICATION AND CRITICISM OF MEAN VARIANCE THEORY

Abstract

The fundamental concept behind MVT is that the assets in an investment portfolio should not be selected individually, each on its own merits. Rather, it is important to consider how each asset changes in price relative to how every other asset in the portfolio changes in price. Investing is a tradeoff between risk and expected return. In general, assets with higher expected returns are riskier. The stocks in an efficient portfolio are chosen depending on the investor's risk tolerance, an efficient portfolio is said to be having a combination of at least two stocks above the minimum variance portfolio. For a given amount of risk, MVT describes how to select a portfolio with the highest possible expected return. Or, for a given expected return, MVT explains how to select a portfolio with the lowest possible risk.