One of the most important and influential economic theories about finance and investment. Modern portfolio theory is based upon the simple idea that diversification can produce the same total returns for less risk. Combining many financial assets in a portfolio is less risky than putting all your investment eggs in one basket. The theory has four basic premises. * Investors are risk averse. * securities are traded in efficient markets. * Risk should be analyzed in terms of an investor’s overall portfolio, rather than by looking at individual assets. * For every level of risk, there is an optimal portfolio of assets that will have the highest expected returns. All of this seems comparatively straightforward now, except perhaps the bit about efficient markets. But it was shocking when it was put forward in the early 1950s by Harry Markowitz, who later won the Nobel Prize for it. According to Mr. Markowitz, when he explained his theory to the high priests of the Chicago school, “Milton Friedman argued that portfolio theory was not economics”. It is now. (See arbitrage pricing theory, capital asset pricing model and black-scholes. )