Beyond the Basics: Unveiling the Complexities of Risk-Return Relationships

The merge between financial theory and practical investing was greatly observed in the 1950s and 1960s, with the formulation of portfolio theory by Markowitz (1952) and later on the Capital Asset Pricing Model of Sharpe (1964) and Lintner (1965) which was built on the basis portfolio theory. Current financial theory is based on three critical assumptions which are (i) market efficieny, (ii) there are arbitrage opportunities for investors and (iii) rationality of investors. The Markowitz the-ory of Markowitz (1952) is a theory that aims to optimize expected discounted re-turns in an investment at a minimum variance, thus achieving an efficient frontier for portfolio selection based on the “expected returns – variance of returns” rule. Markowitz (1952) further suggests that there is need for a probabilistic formulation of security analysis and outlines that better methods that account for more infor-mation can be found.