What is the Modern Portfolio Theory and what are the criticism of this theory?

Modern Portfolio Theory (MPT) is a financial theory that attempts to maximize portfolio expected return for a given amount of portfolio risk, or equivalently minimize risk for a given level of expected return, by carefully choosing the proportions of various assets. It was developed by Harry Markowitz and published under the title "Portfolio Selection" in the Journal of Finance in 1952.

The theory is based on several key assumptions:

1. Investors are rational and avoid risk when possible.
2. Investors have access to the same information and agree about the risk and expected return of all assets.
3. Investors have an average risk tolerance.
4. The markets are efficient, meaning that the prices of traded assets reflect all known information.

The main criticisms of the Modern Portfolio Theory are:

1. Unrealistic Assumptions: The assumptions that all investors have the same information, have a rational behavior, and that markets are always efficient are often criticized as being unrealistic.

2. Overemphasis on Quantification: MPT relies heavily on quantification and mathematical models, which can lead to an over-reliance on numbers and underestimation of qualitative factors.

3. Neglect of Individual Circumstances: MPT assumes that all investors have the same risk tolerance, which is not the case in reality. Individual circumstances and preferences can greatly affect investment decisions.

4. Dependence on Historical Data: MPT uses historical data to predict future returns, which can be misleading as past performance is not always indicative of future results.

5. Neglect of Non-Market Risks: MPT focuses on market risks and often neglects non-market risks such as political risk, regulatory risk, etc.

6. Failure to Prevent Crises: Despite its widespread use, MPT did not prevent the financial crises of 2000 and 2008, leading some to question its effectiveness.