What is a Market Portfolio?
A market portfolio is a theoretical portfolio in which every available type of asset is included at a level proportional to its market value. Described as a group of investments, a portfolio is owned by one individual or organization. The typical investment portfolio may include a variety of assets, but usually does not include all asset types. However, a market portfolio literally includes every asset that exists in the market.
The market value of an investment is described as its current price on the market. The term is also used to refer to the amount for which an asset could presumably be resold. In a market portfolio, investments are held in proportion to their market values in relation to the full value of all included assets.
Often, the concept of a market portfolio is discussed in theoretical terms only. For investment purposes, a true market portfolio would need to include every conceivable asset. As such, the market for such a portfolio would be the world market. The market portfolio concept is important in a variety of financial theories, including Modern Portfolio Theory (MPT). According to the MPT, investors should concentrate on choosing portfolios based on overall risk-reward concepts, rather than focusing on the attractiveness of individual securities.
MPT involves the concept of the efficient frontier on which the market portfolio sits. Introduced by Harry Markowitz, the pioneer of MPT, the efficient frontier is a group 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 offered by a portfolio, relative to the level of risk it entails. The market portfolio, also called the super-efficient portfolio, has the highest Sharpe ratio on the efficient frontier.
When combined with the risk-free asset, it is said that the market portfolio will produce a return rate above the efficient frontier. The risk-free asset is a hypothetical concept. Essentially, the market portfolio would provide for higher return rates than a riskier portfolio on the frontier.
Written by N. Madison
