Market Portfolio
Candlefocus EditorThe market portfolio is an ideal concept that was created in order to determine how to diversify an investor’s portfolio to optimize returns. By including all known assets in the portfolio, investors can maximize diversification and lower their risk. This allows them to create portfolios that are well diversified yet still in line with their specific goals and risk profiles.
The concept of the market portfolio was first proposed by economist Harry Markowitz as part of his Modern Portfolio Theory. Markowitz argued that a portfolio’s value should not be determined by its individual contents, but rather by its expected return compared to the overall risk exposure of the portfolio. He coined the phrase "the efficient frontier" to describe the optimal combination of individual investments that will deliver the highest return for a given level of risk.
Despite its theoretical usefulness in measuring risk, the concept of a market portfolio has faced criticism from economist Avinash D. Roll. roll argued that it is impossible to construct a true market portfolio, because all assets cannot be simultaneously traded on the same markets. In conclusion, a market portfolio is an ideal model to evaluate an investment portfolio’s expected return and risk, but it is impossible to construct one in its purest form.