Portfolio Theory Definition

The quantitative analysis of how investors can diversify their portfolio in order to minimize risk and maximize returns. The theory was introduced in 1952 by University of Chicago economics student Harry Markowitz, who published his doctoral thesis, “Portfolio Selection,” in the Journal of Finance. Markowitz assumed that investors wanted to avoid risk, so he advocated analyzing individual security vehicles to determine how they contribute to the portfolio’s overall risk. The analysis requires close examination of how investments move in relation to one another. Portfolio theory also is called modern portfolio theory or portfolio management theory. In 1990, Markowitz received the Nobel Prize in Economics for his research. There are four aspects of portfolio theory: individual security valuation, which describes a universe of assets by their expected returns and risks; asset allocation, which determines how much an individual should invest into stocks, bonds, or other asset classes; portfolio optimization, which determines which investments offer the best return given the level of the risk; and performance measurement, which divides each investment’s performance into risk categories based upon its own performance, market-related risk, and industry-related risk.
Webster's New World Finance