Modern Portfolio Theory and Risk Management: Assumptions and Unintended Consequences
James P. Hawley
Saint Mary's College of California
University of Texas at San Antonio - Department of Finance
May 10, 2011
The article presents an overview of the assumptions and unintended consequences of the widespread adoption of modern portfolio theory (MPT) in the context of the growth of large institutional investors. We examine the many so-called risk management practices and financial products that have been built on MPT since its inception in the 1950’s. We argue that the very success due to its initial insights had the unintended consequence, given its widespread adoption, of contributing to the undermining the foundation of the financial system in a variety of ways. This study has relevance for both the on-going analyses of the recent financial crisis, as well as for various existing and proposed financial reforms.
Number of Pages in PDF File: 36
Keywords: Prudent Investor Standard, Modern Portfolio Theory, Risk Management, Pension Funds, Portfolio Management, Herding and Widespread Adoption, Unintended Consequences, Model Assumptions
JEL Classification: G14, G23, G11, G00, D70, D80, C92, G28, K22
Date posted: September 7, 2011
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