Teaching Theory Versus Practical Use: The Case of the Modern Portfolio Theory

Abstract:     
In this teaching note, I demonstrate how literal application of the Modern Portfolio Theory (MPT) could lead to inconsistent performance by using data from the U.S. stock markets. The demonstration shows that it is impossible to construct a forecast of an efficient frontier by static analysis of the MPT. While the minimum variance portfolio does produce better risk adjusted return for the investor during the 1996 to 2005 period, the result from 1987 to 1997 period show otherwise. Therefore, using any of the tools derived from MPT without taking into account the time-varying nature would produce inferior results for individual investors.

Keywords: modern portfolio theory, financial education, minimum variance

JEL Classification: G10, G11, G17

Accepted Paper Series