Practical Application of Modern Portfolio Theory

The purpose of this thesis is to investigate if an investor can apply Modern Portfolio Theory (MPT) in order to achieve a higher return than investing in an index portfolio. Combining a strong portfolio that beats the market in the longrun would be the ultimate goal for most investors.The theories that are used to analyze the problem and the empirical findings provide the essential concepts such as standard deviation, risk and return of the portfolio. Further, diversification, correlation and covariance are used to achieve the optimal risky portfolio. There will be a walk-through of the MPT, with the efficient frontier as the graphical guide to express the optimal risky portfolio.


1 Introduction
1.1 Background
1.2 Problem discussion
1.3 Research Questions
1.4 Purpose
1.5 Delimitations
1.6 Pre-study & Approach
1.7 Disposition of the Thesis
2 Frame of Reference
2.1 Expected Return
2.2 Standard Deviation
2.3 Portfolio Risk
2.4 Diversification
2.5 Covariance
2.6 Systematic and Unsystematic Risk
2.7 Relation between Risk and Return
2.8 Modern Portfolio Theory
2.8.1 Efficient Frontier
2.8.2 Capital Allocation Line and Sharpe-ratio
2.8.3 Optimal Portfolio
2.9 Asset Allocation
2.10 Passive and Active Management
2.11 Strategic Asset Management vs. Tactical Asset Management
3 Methodology
3.1 Quantitative vs. Qualitative
3.2 Deductive vs. Inductive Approach
3.3 Predicting the Future with Historical Data
3.4 The Research Approach
3.4.1 Indexes
3.4.2 The Portfolio
3.4.3 Timeframe
3.4.4 Evaluating the Portfolio
3.5 Critique of Chosen Method
3.5.1 Validity
3.5.2 Reliability
4 Empirical Findings and Analysis
4.1 Constructing the Portfolio
4.1.1 Historic Estimates
4.1.2 Statistical Estimation for Each Asset
4.1.3 The Efficient Frontier
4.2 The Optimal Risky Portfolio
4.3 Reweighed Optimal Risky Portfolio
4.4 Performance Evaluation
4.4.1 Non-risk Adjusted Performance
4.4.2 Risk Adjusted Return
4.5 Concluding Analysis
5 Conclusion
6 Final Discussion
6.1 Reflections and Criticism
6.2 Suggestions for Further Research
Appendix 1 – Periodical historical estimates
Appendix 2 – Weights and actual quarterly return
Appendix 3 – Portfolio efficient frontier
Appendix 4 – Risk matrix

Author: Persson, Jakob,Lejon, Carl,Kierkegaard, Kristian

Source: Jönköping University

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