However, the MPT is limited because it can only take into account the available historical market data, and then it uses the same to make assumptions about the future returns. The MPT talks about how investors can construct a diversified portfolio with multiple assets and maximise their returns for a given risk level. It emphasises that the investor’s risk and returns are not independent observations, but they together influence the portfolio’s overall risk and return. The modern portfolio theory is a theory on how risk-averse investors can construct portfolios to maximise the expected returns based on a given market risk level. Understanding the Modern Portfolio Theory The BL model combines the Capital Asset Pricing Theory (CAPM) with Bayesian Statistics and the Modern Portfolio Theory to produce efficient estimates of portfolio weights. It was developed by Fischer Black and Robert Litterman of Goldman Sachs in 1990. It is mainly used by portfolio managers of large investors, like insurance companies and mutual funds, to allocate their resources in various investments and assets. The Black-Litterman Model is a mathematical model used for portfolio allocation and optimisation.
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