Modern Portfolio Theory and Its Problems

Abstract

This chapter presents the key principles of modern portfolio theory (MPT). After a brief review of regression analysis it introduces the capital asset pricing model (CAPM) and its extension, the Fama–French three-factor-model, together with the basic assumptions of the two models and empirical tests. The limitations of the CAPM are pointed out and critical views are presented concerning both models which are based on the fundamental concept of rational investors.