A market portfolio includes all assets in the market in proportion to their market value, while an investment portfolio typically only includes a variety of assets. The market portfolio is important in modern portfolio theory and lies on the efficient frontier, with the highest Sharpe ratio. When combined with a risk-free asset, it produces a rate of return above the efficient frontier.
A market portfolio is a theoretical portfolio in which each type of asset available is included at a level proportional to its market value. An investment portfolio, which is a group of investments, is owned by an individual or organization. A typical may include a variety of assets, but generally does not include all types of assets. However, a market portfolio literally includes all the assets that exist in the market.
The market value of an investment is described as its current market price. The term is also used to refer to the amount for which an asset could be resold. In a market portfolio, investments are held in proportion to their market values relative to the total value of all included assets.
Often this concept is discussed only in theoretical terms. For investment purposes, a true one would need to include every asset imaginable and as such would cover the world market. The concept is important in a variety of financial theories, including modern portfolio theory (MPT). According to the MPT, investors should focus on choosing portfolios based on general risk-reward concepts, rather than focusing on the attractiveness of individual stocks.
MPT involves the concept of the efficient frontier on which the market portfolio lies. Introduced by Harry Markowitz, the MPT pioneer, the efficient frontier is a set of optimal portfolios that serve to maximize expected return for a given level of risk. The Sharpe ratio is a term used to indicate the level of additional return a portfolio offers, relative to the level of risk it carries. The market or super efficient portfolio has the highest Sharpe ratio on the efficient frontier.
When combined with the risk-free asset, the market portfolio is said to produce a rate of return above the efficient frontier. The risk-free asset is a hypothetical concept. Essentially, this portfolio would provide higher rates of return than a riskier portfolio at the frontier.
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