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Modern portfolio theory and risk management: assumptions and unintended consequences

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  • Mehdi Beyhaghi
  • James P. Hawley

Abstract

This article presents an overview of the assumptions and unintended consequences of the widespread adoption of modern portfolio theory (MPT) in the context of the growth of large institutional investors. We examine the many so-called risk management practices and financial products that have been built on MPT since its inception in the 1950s. We argue that the very success due to its initial insights had the unintended consequence, given its widespread adoption, of contributing to the undermining the foundation of the financial system in a variety of ways. This study has relevance for both the ongoing analyses of the recent financial crisis, as well as for various existing and proposed financial reforms.

Suggested Citation

  • Mehdi Beyhaghi & James P. Hawley, 2013. "Modern portfolio theory and risk management: assumptions and unintended consequences," Journal of Sustainable Finance & Investment, Taylor & Francis Journals, vol. 3(1), pages 17-37, January.
    • Handle: RePEc:taf:jsustf:v:3:y:2012:i:1:p:17-37
    DOI: 10.1080/20430795.2012.738600
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    References listed on IDEAS

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    1. Donald MacKenzie, 2006. "An Engine, Not a Camera: How Financial Models Shape Markets," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262134608, December.
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    Cited by:

    1. Madani Bezoui & Mustapha Moulaï & Ahcène Bounceur & Reinhardt Euler, 2019. "An iterative method for solving a bi-objective constrained portfolio optimization problem," Computational Optimization and Applications, Springer, vol. 72(2), pages 479-498, March.
    2. Maria Carolina Rezende de Carvalho Ferreira & Vinicius Amorim Sobreiro & Herbert Kimura & Flavio Luiz de Moraes Barboza, 2016. "A systematic review of literature about finance and sustainability," Journal of Sustainable Finance & Investment, Taylor & Francis Journals, vol. 6(2), pages 112-147, April.
    3. Adam Karp & Gary Van Vuuren, 2019. "Investment Implications Of The Fractal Market Hypothesis," Annals of Financial Economics (AFE), World Scientific Publishing Co. Pte. Ltd., vol. 14(01), pages 1-27, March.

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