Introduced by Harry Markowitz in 1952, the efficient frontier is a concept in finance and portfolio theory, it represents the set of optimal portfolios that offer the highest expected return for a defined level of risk or the lowest risk for a given level of expected return.
Portfolios on or above the efficient frontier are considered efficient because they provide the best risk-return trade-offs. Portfolios below the efficient frontier are suboptimal because they offer lower expected returns for the same level of risk or higher risk for the same expected return.
This theory has some criticisms, the efficient frontier assumes that asset returns follow a normal distribution. However, financial markets often exhibit non-normal behaviors, including fat tails and volatility clustering, futhermore Markowitz posits several assumptions in his theory, such as that investors are rational and avoid risk when possible but the reality proves that the market includes irrational and risk-seeking investors.
