Which theory focuses on diversifying across various asset classes without significantly increasing risk?

The focus on diversifying across various asset classes without significantly increasing risk directly aligns with the principles of Modern Portfolio Theory (MPT). MPT posits that an investor can construct a portfolio of multiple assets that will, on average, yield higher returns while also minimizing risk through diversification.

MPT emphasizes the importance of spreading investments across different asset classes because it reduces unsystematic risk, which is unique to a specific company or industry. By combining assets that are not perfectly correlated, the overall volatility of the portfolio can be lowered. This approach allows investors to create an "efficient frontier," a graph representing the optimal portfolios that offer the highest expected return for a particular level of risk.

The other theories mentioned do not center primarily on the concept of diversification in the same way. The Capital Asset Pricing Model concerns itself more with the relationship between systematic risk and expected return, while Behavioral Finance Theory explores how psychological factors influence investors’ decisions, and the Efficient Market Hypothesis focuses on the idea that market prices fully reflect all available information, suggesting that consistent outperformance through diversification may not be achievable.