The evolution of portfolio theory

Yoram Lustig and Sébastien Page

This chapter will review the evolution of portfolio theory from the 1950s to 2020. Over seven decades, academic researchers and practitioners have been developing portfolio theory from the origins of the concept of an investment portfolio to the contemporary theory and practices.

Organised in chronological order this chapter starts with Markowitz’s modern portfolio theory (MPT), which was introduced in the 1950s and widely regarded as the foundation of portfolio theory. Then the chapter details the next key development: the Capital Asset Pricing Model (CAPM), which was built on the tenets MPT in the 1960s. We then present an overview of the 1970s, a prolific decade for advancement in portfolio and finance theory, including the development of Asset Pricing Theory (APT), the foundation of multi-factor investing, the Black-Scholes option-pricing model and behavioural finance. Moving to the 1980s and 1990s, the chapter looks at the enhancements in predicting future volatility with the Arch model, at the focus on downside risk of post-modern portfolio theory and at the Fama-French three-factor model. The next section reviews developments of the 21st century such as the endowment

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