The Theory of Portfolio Selection

Pamela P. Drake, Frank J. Fabozzi and Francesco A. Fabozzi

Chapter 18 in Introduction to Finance:Financial Management and Investment Management, 2022, pp 513-549 from World Scientific Publishing Co. Pte. Ltd.

Abstract: In this chapter and the next, we set forth theories that are the underpinnings for the management of portfolios: portfolio theory and capital market theory. Portfolio theory deals with the selection of portfolios that maximize expected returns consistent with individually acceptable levels of risk. Using quantitative models and historical data, portfolio theory defines “expected portfolio returns” and “acceptable levels of portfolio risk,” and shows how to construct an optimal portfolio. Capital market theory deals with the effects of investor decisions on security prices. More specifically, it shows the relationship that should exist between security returns and risk if investors constructed portfolios as indicated by portfolio theory. Together, portfolio and capital market theories provide a framework to specify and measure investment risk and to develop relationships between expected security return and risk (and hence between risk and required return on an investment). Moreover, these theories provide a framework for measuring the performance of managed portfolios…

Keywords: Financial Management; Investment Management; Derivatives; Common Stock; Bonds; Company Analysis; Entrepreneurial Finance; Financial Instruments; Financial System; Financial Statements; Time Value of Money; Yields; Present Value; Future Value; Financial Strategy; Dividend Policy (search for similar items in EconPapers)
JEL-codes: G1 G3 N2 O16 (search for similar items in EconPapers)
Date: 2022
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