Beyond Modern Portfolio Theory

Paolo Sironi

An investment in knowledge pays the best interest.

Benjamin Franklin (1706–90)

This chapter sketches the main arguments of this book, which are related to portfolio choice for long-term and goal-based investing, and provides a summary of Modern Portfolio Theory, the Black–Litterman approach, probabilistic scenario optimisation and knowledge-based principles of optimal investing.

INTRODUCTION

Financial markets underwent a profound transformation during the last decade of the 20th century. The integration of international markets, fostered by broader deregulation of cross-border capital flows, was accompanied by strong financial innovation: the landscape of investment opportunities became more accessible yet heterogeneous (ie, derivatives, structured products, securitisation) and also more interdependent, as revealed by the contagion risk that characterised the global financial crisis in 2007–12. This affected the dynamics of the correlations among global asset classes, as it appeared not only that risks become over-concentrated more often than expected, instead of being diversified away across a larger number of players, but also that asset classes co-move faster than