Modern Portfolio Theory (MPT), developed by Harry Markowitz (1952), is the mathematical foundation for portfolio construction. Core insight: Combining assets with imperfect correlation reduces portfolio volatility below the weighted average of individual volatilities — this is diversification benefit. MPT defines the efficient frontier: the set of portfolios offering maximum return for a given risk level (or minimum risk for a given return). Rational investors should only hold efficient portfolios. Inputs: Expected returns, volatilities, and correlations for all assets. Outputs: Optimal weights (min variance portfolio, max Sharpe portfolio, etc.). Limitations: Garbage in, garbage out — small changes in expected return assumptions cause massive weight shifts. Assumes normal distributions (ignores tail risk). Despite limitations, MPT underpins modern asset allocation.