Chapter: 12 Portfolio Theory & The Benefits of Diversification

Section: 1 Diversification

Long before any theories of modern finance were developed, people knew one basic tenet of wisdom: “do not put all your eggs in one basket”. Hence, the benefits of diversification have been known among people for as long as investments have taken place. In 1952, Professor Harry Markowitz presented the portfolio theory and he proved and quantified the benefits of diversification.


Without going into much detail, we will show from the following example how an efficient portfolio allocation can take place with the help of the risk measures explained in the previous chapter. For the sake of simplicity, we will just be analyzing a two stock portfolio and its allocation.