The art of professional portfolio management experienced a revolution after the concepts in Harry Markowitz’s seminal paper explained how investors view risk and return. In his work, he derived formulas used to calculate volatility and expected return of a diversified portfolio with the ultimate goal of his to find the best portfolio allocation to maximize return for a given level of risk. His work is based on three assumptions: 1) Investors are generally risk-averse, 2) investors base their portfolio decisions on risk and expected return only, and 3) investors measure risk as the variance (or standard deviation) of expected returns. The third assumption led Markowitz to conceive the idea of a portfolio being “mean-variance” efficient when no other portfolio offers a higher expected return at a given level of risk, or lower level of risk for a given expected return. Creating portfolios that have higher mean-variance efficiency depends on certain statistical characteristic...
Price-based perspective on market behavior