STREET DOGS: Guiding principle behind MPT
Nearly ten years after the financial crisis we’re still relying on the same risk management model
From an article by Scott Jacobs and Truman Semans of Intersect: The financial crisis may seem to be in the rear-view mirror, but we haven’t learned some of its most important lessons. Among those is a largely unacknowledged one: the failure of our primary risk-management methodology, modern portfolio theory (MPT). The guiding principle behind MPT is that by diversifying investments among different "uncorrelated" assets classes, an investor can create a resilient portfolio to weather any condition. But as the financial crisis taught us, some risks cut across asset classes and can bring them all down at the same time. According to MPT, the fixed income (asset class), US (geography), real estate (sector), where subprime mortgage investments sit, should have been isolated. But when those investments failed, contagion across asset classes, sectors and geographies wiped out $34.4-trillion of global wealth by March 2009, less than a year after the first signs of individual asset failures. ...
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