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The Black–Litterman model explained

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  • Wing Cheung

    (Nomura International plc)

Abstract

Active portfolio management is about leveraging information. The Black and Litterman Global Portfolio Optimisation Model (BL) sets information processing in a Bayesian analytic framework. In this framework, the portfolio manager needs only produce views and the model translates the views into security return forecasts. As a portfolio construction tool, the BL model is appealing both in theory and in practice. Although there has been no shortage of literature exploring it, the model still appears somehow mysterious, and suffers from practical issues. This article is dedicated to enabling a better understanding of this model, and features: an economic interpretation; a clarification of the model's assumptions and formulation; implementation guidance; a dimension-reduction technique to enable large portfolio applications; and a full proof of the main result in the Appendix. We also provide a checklist of other practical issues that we aim to address in our forthcoming articles.

Suggested Citation

  • Wing Cheung, 2010. "The Black–Litterman model explained," Journal of Asset Management, Palgrave Macmillan, vol. 11(4), pages 229-243, October.
    • Handle: RePEc:pal:assmgt:v:11:y:2010:i:4:d:10.1057_jam.2009.28
    DOI: 10.1057/jam.2009.28
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    References listed on IDEAS

    as
    1. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May.
    2. S Satchell & A Scowcroft, 2000. "A demystification of the Black–Litterman model: Managing quantitative and traditional portfolio construction," Journal of Asset Management, Palgrave Macmillan, vol. 1(2), pages 138-150, September.
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    Cited by:

    1. Randy O'Toole, 2013. "The Black–Litterman model: A risk budgeting perspective," Journal of Asset Management, Palgrave Macmillan, vol. 14(1), pages 2-13, February.
    2. Frieder Meyer-Bullerdiek, 2021. "Out-of-sample performance of the Black-Litterman model," Journal of Finance and Investment Analysis, SCIENPRESS Ltd, vol. 10(2), pages 1-2.

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