Critically discuss the Harry Markowitz portfolio theory and its developments (Business & Marketing Essay)
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THE HARRY MARKOWITZ PORTFOLIO THEORY AND ITS DEVELOPMENTS
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The Harry Markowitz Portfolio Theory and Its Developments
Introduction
Markowitz's portfolio theory presents one of the various pillars of theoretical finance developed by Markowitz in 1959. According to Markowitz's theory, investors have the capability of designing a portfolio that could maximize returns by quantifying the existing amount of risk. In this case, the investors can reduce the level of risk through diversification of assets alongside the allocation of assets concerning their investments through the quantitative methodology. Harry Markowitz's theory allows for investor analysis on the various risks relative to the expected returns. In this theory, there's an attempt to maximize the portfolio expected return for a certain amount of portfolio risk or rather equivalently minimizing risks for a given level of expected return. This is done by making careful choices on different assets' proportions (Wallengren and Sigurdson, 2017).
Critical Analysis of Markowitz's Portfolio Theory
The modern portfolio theory (MPT) is theoretically relevant from the perspective of other researchers. However, its nature of using simplistic assumptions provides a predominant bias. There is the question surrounding the viability of the theory as an investment strategy since its financial market model does not necessarily match the real-world experiences in numerous ways. The various basic assumptions that underlie the theory receive up-to-date challenges of equal measure from the relevant fields that include behavioral economics (Berk and Tutarli, 2020).
Notably, the various efforts that could translate such theoretical foundation as shown in theory into some viable portfolio construction algorithm encounter technical difficulties. This originates from the status of instability as per the original optimization issue as per the available data. Further, the theory cannot model the market. In this case, the risk, return, and correlation measures applicable by the theory follow the expected or instead forecast values. This means that they represent the various mathematical statements concerning the future. Practically, investors are required to be able to substitute predictions based on historical asset return measurement alongside value volatility within such equations. However, there's always some pattern of such expected values failing to account for existing new circumstances within the present environment that never existed at the point of historical data generation. Fundamentally, there is also the aspect of investors sticking to parameter estimation from previous market data since the theory attempts to model risk in terms of anticipated losses while not indicating the cause of such failures (Berk and Tutarli, 2020).
Simultaneously, the theory considers decision investments' personal, environmental, strategic, and social perspectives. In this case, the theory only considers maximization of risk-adjusted returns disregarding other consequent results. The theory's complete dependence on asset prices creates some vulnerability to various standard market failures. These entail those arising from information asymmetry...
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