Portfolio Diversification and Markowitz Theory Essay

Portfolio Diversification and Markowitz Theory - Essay Example However, there is a claim from Swisher & Kasten (2005) that a post-modern portfolio theory factoring in the role emotions and subjectivities has emerged but the leading journals do not confirm the claim. Gitman & Joehnk (1996, p. 670) attribute to Harry Markowitz, a trained mathematician, the development of the first set of theories â€Å"that form the basis of modern portfolio.† Modern portfolio theory is â€Å"an approach to portfolio management that uses statistical measures to develop a portfolio plan† (Gitman & Joehnk 1996, p. 670). Other than Markovitz, â€Å"several other scholars and investment experts have contributed to the theory in the intervening years† (Gitman & Joehnk 1996, p. 670). Gitman & Joehnk (1996, p. 671) identified that some of the key concepts used by the theory â€Å"are expected returns and standard deviations of returns for both securities and portfolios and the correlations between returns.† Gitman & Joehnk (1996, p. 673) point ed out that at the theoretical level, the optimal portfolio choice is made by an investor at the point of tangency between the investor’s indifference curve and his or her efficient frontier of investment. The efficient frontiers of investments consist of a set of combination of risks and returns deemed most acceptable to the investor. The investor is assumed to accept higher risks provided returns will be higher. This is shown in Figure 1 where the Is are the indifference curves of the investor associated with the investor’s utility. Figure 1. Indifference curves, efficient frontier, and optimal portfolio. Source: Gitman & Joehnk 1996, p.