Modern Portfolio Theory, Financial Engineering, and Their Roles in Financial Crises

The article "Modern portfolio theory, financial engineering and its role in financial crisis" discusses modern portfolio theory and financial engineering. The author refers to the role of modern portfolio theory and financial engineering in the financial crisis. In addition, the authors state why elegant mathematics can lead to bad policies. This subject summarizes most of the points described in this article. This paper starts with defining the concept of modern portfolio theory (MPT).

Under the general name of contemporary portfolio theory announced entitled "Portfolio Selection" by Dr. Harry Markowitz in 1952, science has developed with focus on market and financial risk management. In modern portfolio theory, the variance (or standard deviation) of the portfolio is used as the risk definition. Credit risk, also called default risk, is the risk associated with the default of the borrower (not paid as promised). Investor loss includes loss of principal and interest, a decrease in cash flow, and an increase in collection expenses. Investors can also undertake credit risk by using leverage directly or indirectly. For example, investors can purchase investments using margins. Alternatively, the investment can be used directly or indirectly, or it depends on a repurchase, a forward commitment or a derivative

Today, financial data and equity investment are based on the principles of modern portfolio theory. It provides insight as to how to build a portfolio of investments and is thus selected to maximize the expected return (or benefit) of risk factors given at different points in time. Basically it is an optimization process and the Quantum computer is excellent for these optimization problems.

Modern Portfolio Theory (MPT) was one of the most important contributions to financial economics, developed by Harry Markowitz in 1952. MPT is a mathematical framework for building a unique ideal portfolio that reduces while maximizing expected returns. Volatility Markowitz designed the concept of "effective boundary" to compare the expected yield and volatility (including various amounts of assets) of various asset classes and various asset portfolios. Each portfolio is plotted on the chart, portfolio risk (standard deviation) on the horizontal axis, and the expected rate of return on the vertical axis.