<p>Welcome to EC.SE! Hopefully this will help.</p>

<p>I don't think this characterization is correct. These are not opposing theories. Modern portfolio theory is based on the idea that people choose portfolios to maximize their utility. After that, it depends on the specification of utility. As a simple example, a person with a quadratic utility function will choose a portfolio that is mean-variance efficient. The particular portfolio allocation will depend on the risk-aversion parameter in the utility function.</p>

<p>For examples discussed in other questions on the site, see <a href="https://economics.stackexchange.com/questions/4515/calculating-the-optimal-portfolio-for-an-investor-with-quadratic-utility">Calculating the optimal portfolio for an investor with quadratic utility</a> and 
<a href="https://economics.stackexchange.com/questions/3275/portfolio-choice-problem-of-a-cara-investor-with-n-risky-assets">Portfolio choice problem of a CARA investor with n risky assets</a>.</p>

CC BY-SA 3.0
2015-04-29T05:48:09.183Z
2015-04-29T05:48:09.183Z
2017-04-13T12:51:38.253Z
jmbejara
<p>Harry Markowitz invented <a href="http://en.wikipedia.org/wiki/Modern_portfolio_theory" rel="nofollow">modern portfolio theory</a>. If agents have quadratic utility or asset returns follow jointly normally distributed random variables, then his process describes how to construct optimal portfolios given the expected returns and forward-looking covariance of asset returns. If those are not your preferences and assets returns follow a different process (as we think they do), then you need a dynamic programming approach (<a href="https://web.stanford.edu/~boyd/papers/pdf/dyn_port_opt.pdf" rel="nofollow">like this</a>) for optimal portfolio construction. </p>

CC BY-SA 3.0
2015-04-29T12:43:46.533Z
2015-04-29T12:43:46.533Z
BKay
<p>I'm currently trying to wrap my head around modern portfolio theory and would love a simple explanation on how it differs from a marginal utility model (if at all).</p>

<p>As I am understanding it, MPT allows you to create a portfolio of assets in optimal quantities at a given risk factor.  However, isn't this basically the same as judging the marginal risk return of each asset and then funding each to its relative "risk return" (e.g. fund Asset A until marginal return is less than asset B, then fund asset B, fund asset B until marginal return is less than C, then fund C).</p>

<finance><utility><portfolio-theory>
Modern Portfolio Theory Vs Marginal Utility Theory
JDilla
# Modern Portfolio Theory Vs Marginal Utility Theory

(Asked by: username_0 on 2015-04-29)

I'm currently trying to wrap my head around modern portfolio theory and would love a simple explanation on how it differs from a marginal utility model (if at all).

As I am understanding it, MPT allows you to create a portfolio of assets in optimal quantities at a given risk factor. However, isn't this basically the same as judging the marginal risk return of each asset and then funding each to its relative "risk return" (e.g. fund Asset A until marginal return is less than asset B, then fund asset B, fund asset B until marginal return is less than C, then fund C).

**Tags:** finance, utility, portfolio-theory


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## 2 answers

### Answer by username_1 on 2015-04-29. Score: 2

Welcome to EC.SE! Hopefully this will help.

I don't think this characterization is correct. These are not opposing theories. Modern portfolio theory is based on the idea that people choose portfolios to maximize their utility. After that, it depends on the specification of utility. As a simple example, a person with a quadratic utility function will choose a portfolio that is mean-variance efficient. The particular portfolio allocation will depend on the risk-aversion parameter in the utility function.

For examples discussed in other questions on the site, see [Calculating the optimal portfolio for an investor with quadratic utility](https://economics.stackexchange.com/questions/4515/calculating-the-optimal-portfolio-for-an-investor-with-quadratic-utility) and
[Portfolio choice problem of a CARA investor with n risky assets](https://economics.stackexchange.com/questions/3275/portfolio-choice-problem-of-a-cara-investor-with-n-risky-assets).


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### Answer by username_2 on 2015-04-29. Score: 0

Harry Markowitz invented [modern portfolio theory](http://en.wikipedia.org/wiki/Modern_portfolio_theory). If agents have quadratic utility or asset returns follow jointly normally distributed random variables, then his process describes how to construct optimal portfolios given the expected returns and forward-looking covariance of asset returns. If those are not your preferences and assets returns follow a different process (as we think they do), then you need a dynamic programming approach ([like this](https://web.stanford.edu/~boyd/papers/pdf/dyn_port_opt.pdf)) for optimal portfolio construction.


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