The theory developed by H. M. Markowitz (1927– ) that rational investors are averse to taking increased risk unless they are compensated by an adequate increase in expected return. The theory also assumes that for any given expected return, most rational investors will prefer a lower level of risk and for any given level of risk they will prefer a higher return than a lower return. A set of efficient portfolios can be calculated from which the investor will choose the one most appropriate for their risk profile. The practical conclusions of the theory are that investors should diversify widely and determine their levels of risk by lending a proportion of their assets or borrowing to buy more risky assets. See also Markowitz model; portfolio insurance.
Subjects: Financial Institutions and Services.