Black Litterman and Robust Portfolio Optimization

11112012 p kolm 8 prologue to the black litterman

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Unformatted text preview: 99)) RISK AND PORTFOLIO MANAGEMENT WITH ECONOMETRICS, VER. 11/11/2012. © P. KOLM. 8 Prologue to The Black-Litterman Model Practical caveats of classical M-V: o Significant impact from estimation error in expected returns o The investor is required to provide estimates of expected returns and covariances of all assets o Hard to incorporate relative forecasts: “B will outperform A by 0.5% over the next month” Black-Litterman model in a nutshell: o “Market based” shrinkage estimator of the expected returns o Resulting expected return estimates are “confidence weighted” averages of market equilibrium and investors’ views o Investors’ views can be either absolute or relative o No need to have estimate/views on all assets RISK AND PORTFOLIO MANAGEMENT WITH ECONOMETRICS, VER. 11/11/2012. © P. KOLM. 9 Distributional Assumptions in B-L Assets: R ~ N (m, S) Market equilibrium: m ~ N (p, tS) Investor’s views: P m N (q, W) where m: p: tS: q: P: expected return (i.e. m = E (R)) CAPM equilibrium returns (prior) uncertainty in equilibrium inv...
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This document was uploaded on 02/17/2014 for the course COURANT G63.2751.0 at NYU.

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