Investor's wiki
en English
Navigation
Home Glossary
InvestingStocksBondsCryptoPersonal FinanceFundamental AnalysisTechnical AnalysisTradingBankingTaxes
Disclaimer Terms of Use Privacy Policy Cookie Policy
Navigation
Home Glossary
InvestingStocksBondsCryptoPersonal FinanceFundamental AnalysisTechnical AnalysisTradingBankingTaxes
Disclaimer Terms of Use Privacy Policy Cookie Policy

Post-Modern Portfolio Theory (PMPT)

Post-Modern Portfolio Theory (PMPT)
InvestingQuantitative Analysis

What Is the Post-Modern Portfolio Theory (PMPT)?

The post-modern portfolio theory (PMPT) is a portfolio optimization methodology that utilizes the downside risk of returns rather than the mean variance of investment returns utilized by the modern portfolio theory (MPT). The two hypotheses portray how risky assets ought to be valued, and the way that rational investors ought to use diversification to accomplish portfolio optimization. The difference lies in every theory's definition of risk, and what that risk means for expected returns.

Figuring out the Post-Modern Portfolio Theory (PMPT)

The PMPT was imagined in 1991 when software designers Brian M. Rom and Kathleen Ferguson perceived there to be huge imperfections and limitations with software in view of the MPT and tried to separate the portfolio construction software developed by their company, Sponsor-Software Systems Inc.

The theory utilizes the standard deviation of negative returns as the measure of risk, while the modern portfolio theory involves the standard deviation of all returns as a measure of risk. After economist Harry Markowitz spearheaded the concept of MPT in 1952, later winning the Nobel Prize for Economics for his work focused on the foundation of a formal quantitative risk and return system for pursuing investment choices, the MPT stayed the primary school of thought on portfolio management for a long time and it keeps on being used by financial managers.

Rom and Ferguson noted two important limitations of the MPT: its assumptions that the investment returns of all portfolios and securities can be precisely addressed by a joint curved distribution, for example, the normal distribution, and that the variance of portfolio returns is the right measure of investment risk.

Rom and Ferguson then, at that point, refined and presented their theory of PMPT in a 1993 article in The Journal of Performance Management. The PMPT has proceeded to advance and extend as scholastics worldwide have tried these hypotheses and confirmed that they have merit.

Parts of the Post-Modern Portfolio Theory (PMPT)

The differences in risk, as defined by the standard deviation of returns, between the PMPT and the MPT is the key factor in portfolio construction. The MPT accepts symmetrical risk while the PMPT expects asymmetrical risk. Downside risk is measured by target semi-deviation, named downside deviation, and catches what investors fear most: having negative returns.

The Sortino ratio was the principal new element brought into the PMPT rubric by Rom and Ferguson, which was designed to supplant MPT's Sharpe ratio as a measure of risk-adjusted return, and developed its ability to rank investment results. Volatility skewness, which measures the ratio of a distribution's percentage of total variance from returns over the mean to the returns below the mean, was the second portfolio-examination statistic to be added to the PMPT rubric.

Post-Modern Portfolio Theory (PMPT) versus Modern Portfolio Theory (MPT)

The MPT centers around making investment portfolios with assets that are non-connected; assuming one asset is negatively impacted in a portfolio, different assets are not really so. This is the thought behind diversification. For instance, in the event that an investor has oil stocks and technology stocks in their portfolio and new government regulation on oil companies harms the profits of oil companies, their stocks will lose esteem; notwithstanding, the technology stocks will not be impacted. The gains in the tech stocks will offset the losses of the oil stocks.

The MPT is the primary method wherein investment portfolios are developed today. The theory is the basis behind passive investing. There are, in any case, numerous investors that look to increase their returns past what passive investing can bring or reduce their risk in a more huge manner; or both. This is known as seeking alpha; returns that beat the market, and is the thought behind actively managed portfolios, most frequently executed by investment managers, especially hedge funds. This is where the post-modern portfolio theory becomes possibly the most important factor, by which portfolio managers try to comprehend and consolidate negative returns in their portfolio computations.

Features

  • Brian M. Rom and Kathleen Ferguson, two software designers, made the PMPT in 1991 when they trusted there to be imperfections in software design utilizing the MPT.
  • The PMPT involves the standard deviation of negative returns as the measure of risk, while modern portfolio theory involves the standard deviation of all returns as a measure of risk.
  • The Sortino ratio was acquainted into the PMPT rubric with supplant MPT's Sharpe ratio as a measure of risk-adjusted returns and enhanced its ability to rank investment results.
  • The Post-modern portfolio theory (PMPT) is a methodology utilized for portfolio optimization that uses the downside risk of returns.
  • The PMPT remains as opposed to the modern portfolio theory (MPT); the two of which detail how risky assets ought to be valued while focusing on the benefits of diversification, with the difference in the hypotheses being what they characterize risk and its mean for on returns.