- The risk, return, and correlation measures used by Modern portfolio theory (MPT) are based on expected values, such expected values fail to take account of new circumstances that did not exist when the historical data were generated
- The risk measurements used in MPT are probabilistic because MPT models risk in terms of the likelihood of losses based on past market data and not why the losses occur.
- MPT attempts to minimize risks in the form of variance. However, this metric doesn’t reflect investors’ true concerns in practice. Variance is symmetric, so it punishes high returns the same way as high losses. However, investors care more about loss than gain, so the perception of risk is asymmetric in nature. Coherent risk measures should be a better metric that reflects investors’ preference
- MPT assumes that returns follow Gaussian distribution. However, many scholars suggest that returns might follow other distributions such as stable distributions
- MPT relies on the efficient-market hypothesis and assumes that share price fluctuation is a risk measure. However, building a portfolio based on historical volatility is a questionable premise criticized by Sir John Templeton