Modern Portfolio Theory
Modern portfolio theory is Markowitz mean-variance optimization — diversify covariances, not just names, to get more return per unit of variance.
Definition
Pick weights to minimize w′Σw for a target return, or maximize return for a variance budget. Inputs (means especially) are fragile. Constraints and shrinkage are how it survives contact with a live book.
Why it matters
Every ‘efficient frontier’ slide is this. Error-maximizing optimizers are also this, without shrinkage.
Case
An unconstrained MVO piles into the highest in-sample Sharpe names and blows up live. The math was right; the means were fiction.
How to read it
Trust the covariances more than the means. Then add constraints that match the mandate, not the backtest.
Key papers
Landmark references with real publisher or arXiv links — not token-overlap noise.
- Portfolio SelectionMarkowitz · 1952 · Journal of FinanceThe mean-variance paper.