Theory Of Harry Markowitz And The Portfolio Selection Process

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Harry Markowitz is highly esteemed as a pioneer in theoretical justification of investor’s behavior and development of optimization model for portfolio selection process. In 1990, Markowitz received a Nobel Prize for his contributions to financial economics and corporate finance, the first time presented in his “Portfolio Selection” (1952) and more extensively in his monography “Portfolio Selection: Efficient Diversification” (1959). His seminal works form the foundation of the Modern Portfolio Theory (MPT). Markowitz’ ideas ware later substantially expanded by his Nobel Prize co-winner, William Sharpe, who is generally recognized for his Capital Asset Pricing Model (CAPM) concerning with financial asset price formation.

In the paper “Portfolio selection theory” Markowitz characterizes the Mean-Variance model as both normative theory, which offers a standard or norm of behavior that investors should pursue in constructing a portfolio, and positive hypothesis,
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In general, risk measure should assess the probability, essence, and intensity of a deviation from the expected value of return. Nevertheless, Markowitz portfolio selection theory states that the risk of each asset in isolation is not crucial, but the contribution of each asset to the risk of the portfolio is decisive. In context of a portfolio, the total risk of a security can be divided into two basic components: systematic risk (also known as market risk or common risk) and unsystematic risk (also known as diversifiable risk). Although, since the returns on different assets are correlated to at least some degree, unsystematic risk can never be completely eliminated regardless of how many types of assets are aggregated in a portfolio, it can be significantly diminished by the diversification of securities within a
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