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Standard portfolio theory, which is at the core of standard so-called neo-classical capital market theory, presupposes that investors are rational. Broadly speaking, investors behave as if they were maximizing expected utility. This somewhat old Markowitz-Tobin framework, still constitutes the core of the asset management literature. It has disappointing predictions, however, as it predicts that investors should invest in globally diversified and similar portfolios.
This theoretical prediction is known as Tobin’s mutual fund separation theorem. Of course, the prediction is not correct as most investors hold very different portfolios and financial advisors also recommend very differentiated portfolios to different investors, a phenomenon known as the asset allocation...
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