Study Of Modern Portfolio Theory

Modern Portfolio Theory (MPT) mainly focuses on the method by which investors maximize the expected utility when they balance the return and risk of their investment and the resulting impact on the entire capital market. MPT is the basis of modern finance and investment theory as well as modern monetary theory. This thesis concentrates on portfolio selection by investors under uncertainty and the efficiency, the equilibrium, and as well as the pricing mechanism of capital market. It suggests improvement of the MPT test model by utilizing the method of econometrics.Starting from the micro-analysis of investment portfolio selection, Chapter 1 discusses how investors establish the effective frontier, minimize investment risk, and maximize the expected utility. It gives a systematic analysis of the Markowitz's portfolio theory and studies formation of portfolio under the no-risk condition and the no-short-sale constraint. In the meantime, by constructing investors' utility function related to return and risk, consumption and investment, it applies the Expected Utility Theory to MPT. As a result, it accurately reflects the attitude of investors towards return/loss and reveals the effect of investors' preference on portfolio selection.Measurement of investment risk by variance has to assume an artificial normal distribution of return. In contrast, Chapter 2 uses two other methods of measuring risk, DO WNSIDE RISK and VaR and thus gives an in-depth analysis of the tools of risk measurement under non-normal distribution of return. Especially it focuses on the efficiency of Lower Partial Moments (LPM, one of the methods in DOWNSIDE RISK), which is applicable to all types of utility functions, and solves the portfolio problem under the VaR constraint. Also, in the VaR framework, it defines risk premium index similar to the Sharpe Index and proposes a principle similar to the Two Funds Separation Theorem in the mean-variance analysis in the presence of non-risk assets. Consequently, it improves the efficiency of asset allocation models.Chapter 3 analyzes the premise of MPT, which is the Efficient Market Hypothesis (EMH). By researching the development of EMH, it discusses the pros and cons of EMH and its meaning to our capital markets. By analyzing the definition of EMH and the characteristics of the weak, semi-strong, and strong EMH, it categorizes many empirical tests of this theory by international researchers into two general testing approaches.Using the equilibrium theory, Chapter 4 studies how to assess return of risk assets, measurement of risk, and the relation between the two when the market reaches the equilibrium if all investors invest according to the Markowitz's theory. Therefore, it reveals the underlying logic of the Capital Assets Pricing Model (CAPM). Not using some stringent assumptions in standard CAPM, it systematically analyzes the static non-standard CAPM under the conditions of no-short-sale, absence of no-risk assets, presence of persona] taxes, presence of non-marketable assets, heterogeneous expectations, and presence of price controllers. Additionally, it analyzes the Intertemporal CAPM (ICAPM) and the Consumption CAPM (CCAPM) and thus has provided the basis for researching the dynamic capital market pricing theory.Chapter 5 uses the Arbitrage Pricing Theory (APT). It incorporates other risk factors besides market risk into the analysis of assets return, utilizes the One Price Rule, deduces an Arbitrage Pricing Model, and proves that CAPM is a special case of APT. Based on the above, it studies the procedures of the explored factor analysis and the specified factor analysis of APT. It compares the above two methods and thus improves the operability of APT.Based the theoretical analysis of the first five chapters, Chapter 6, from the viewpoint of econometrics, concentrates on the test model of MPT. First, it proposes a model to test the efficiency of our security market. Especially, it has utilized many cutting-edge developments in econometrics such as unit root test, time series a...