Post-Modern Portfolio Theory - Explained
What is Post-Modern Portfolio Theory?
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Table of ContentsWhat is Post-Modern Portfolio Theory?How Does Post-Modern Portfolio Theory Work?The Elements of PMPT
What is Post-Modern Portfolio Theory?
A system for the distribution of portfolio investments based on assets versus the risk of negative returns, also known to as downside risk. This defined as Post-Modern Portfolio Theory. In the post-modern portfolio theory, the risk of returns falling below the minimum acceptable return (MAR) is assessed through downside risk measurements. It represents an extension of conventional modern portfolio (MPT, mean-variance analysis or MVA application) theory. Both theories suggest how prudent investors can maximize their portfolios using diversification and price as a risky asset; they can be differentiated by the concept of risk in each principle and how this risk affects anticipated gains.
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How Does Post-Modern Portfolio Theory Work?
PMPT is an MPT generalization. MPT is a PMPT with the return and variance usually distributed as a risk calculation. Since PMPT is more generalized than MPT, there is no particular formula for it; more than one method is available for risk assessment, and there are many for modeling return distribution. The minimum acceptable return (MAR) measured by PMPT is determined by the investor using it. Since the MAR is investor specific, it means there is an endless number of efficient frontiers, one suitable for every minimum return. This implies that it represents more accurately the fact that not all investors have exact or similar interests or tolerance for risk. History In 1991, Brian M.Rom and Kathleen Ferguson created the Post-Modern Portfolio Theory in order to distinguish construction software portfolio from the construction theory portfolio created by their firm, Investment Technologies. Empirical research began at San Francisco State University's Pension Research Institute in 1981. The principle presented by Peter Fishburn in 1977 was adapted to Pension Fund Management by Dr. Hal Forsey and Dr. Frank Sortino. As a result, Brian Rome was approved by PRI to market in 1988 as an asset allocation model. It incorporates multiple theoretical research writers and has been spreading over a number of decades as university academics in many countries have checked such ideas to see whether they are worthwhile or not.
The Elements of PMPT
Downside risk (DR): is calculated by the target semicircular deviation, called downside deviation (the square root of the target semivariance) The percentage rankings are expressed in the same manner as the standard deviation. Sortino Ratio: In the PMPT segment the first new element was the Sortino ratio produced by Investment Technologies, the company of Rome. The calculation of risk-adjusted return was designed to replace the Sharpe ratio of MPT. Volatility Skewness: The second metric presented by Rome and Ferguson in the PMPT rubric is volatility skewness. It compares the percentage of the total variance of the returns of distribution above the average to the percentage of the total deviation of the distribution below that of the average.