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Stable distributions in the Black-Litterman approach to asset allocation

Author

Listed:
  • Rosella Giacometti
  • Marida Bertocchi
  • Svetlozar T. Rachev
  • Frank J. Fabozzi

Abstract

The integration of quantitative asset allocation models and the judgment of portfolio managers and analysts (i.e. qualitative view) dates back to a series of papers by Black and Litterman in the early 1990s. In this paper we improve the classical Black-Litterman model by applying more realistic models for asset returns (the normal, the t-student, and the stable distributions) and by using alternative risk measures (dispersion-based risk measures, value at risk, conditional value at risk). Results are reported for monthly data and goodness of the models are tested through a rolling window of fixed size along a fixed horizon. Finally, we find that incorporation of the views of investors into the model provides information as to how the different distributional hypotheses can impact the optimal composition of the portfolio.

Suggested Citation

  • Rosella Giacometti & Marida Bertocchi & Svetlozar T. Rachev & Frank J. Fabozzi, 2007. "Stable distributions in the Black-Litterman approach to asset allocation," Quantitative Finance, Taylor & Francis Journals, vol. 7(4), pages 423-433.
    • Handle: RePEc:taf:quantf:v:7:y:2007:i:4:p:423-433
    DOI: 10.1080/14697680701442731
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    Citations

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    Cited by:

    1. Luna-Ramírez, Susana Arango & Diego A. Agudelo, 2017. "Does Black-Litterman Model adds value to a MILA portfolio?," Documentos de Trabajo de Valor Público 16940, Universidad EAFIT.
    2. Susana Luna-Ramírez & Diego A. Agudelo, 2017. "Agrega valor el modelo Black-Litterman en portafolios del Mercado Integrado Latinoamericano (MILA)?," Documentos de Trabajo de Valor Público 16959, Universidad EAFIT.
    3. Luna-Ramirez, Susana & Agudelo, Diego A., 2019. "¿Agrega Valor el Modelo Black-Litterman en Portafolios del Mercado Integrado Latinoamericano (MILA)? Evaluación Empírica 2008-2016 || Does the Black-Litterman Model Add Value in Portfolios of the Inte," Revista de Métodos Cuantitativos para la Economía y la Empresa = Journal of Quantitative Methods for Economics and Business Administration, Universidad Pablo de Olavide, Department of Quantitative Methods for Economics and Business Administration, vol. 27(1), pages 55-73, June.
    4. Broda, Simon A. & Haas, Markus & Krause, Jochen & Paolella, Marc S. & Steude, Sven C., 2013. "Stable mixture GARCH models," Journal of Econometrics, Elsevier, vol. 172(2), pages 292-306.
    5. Rosella Giacometti & Domenico Mignacca, 2010. "Using the Black and Litterman framework for stress test analysis in asset management," Journal of Asset Management, Palgrave Macmillan, vol. 11(4), pages 286-297, October.
    6. Abootaleb Shirvani, 2020. "Stock Returns and Roughness Extreme Variations: A New Model for Monitoring 2008 Market Crash and 2015 Flash Crash," Applied Economics and Finance, Redfame publishing, vol. 7(3), pages 78-95, May.
    7. Peng W. He & Andrew Grant & Joel Fabre, 2013. "Economic value of analyst recommendations in Australia: an application of the Black–Litterman asset allocation model," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 53(2), pages 441-470, June.
    8. Kolm, Petter & Ritter, Gordon, 2017. "On the Bayesian interpretation of Black–Litterman," European Journal of Operational Research, Elsevier, vol. 258(2), pages 564-572.
    9. Harris, Richard D.F. & Stoja, Evarist & Tan, Linzhi, 2017. "The dynamic Black–Litterman approach to asset allocation," European Journal of Operational Research, Elsevier, vol. 259(3), pages 1085-1096.
    10. Palczewski, Andrzej & Palczewski, Jan, 2019. "Black–Litterman model for continuous distributions," European Journal of Operational Research, Elsevier, vol. 273(2), pages 708-720.
    11. Sahamkhadam, Maziar & Stephan, Andreas & Östermark, Ralf, 2022. "Copula-based Black–Litterman portfolio optimization," European Journal of Operational Research, Elsevier, vol. 297(3), pages 1055-1070.
    12. Fuhrer, Adrian & Hock, Thorsten, 2023. "Uncertainty in the Black–Litterman model: Empirical estimation of the equilibrium," Journal of Empirical Finance, Elsevier, vol. 72(C), pages 251-275.
    13. Marc S. Paolella, 2016. "Stable-GARCH Models for Financial Returns: Fast Estimation and Tests for Stability," Econometrics, MDPI, vol. 4(2), pages 1-28, May.
    14. Humberto Valencia Herrera, 2011. "Value at Risk and Return from the Use of Bayesian Methods for Stress Testing in a World Asset Allocation and the 2008-2009 Crisis," Revista de Administración, Finanzas y Economía (Journal of Management, Finance and Economics), Tecnológico de Monterrey, Campus Ciudad de México, vol. 5(1), pages 33-49.
    15. Zhang, Zhichao & Chau, Frankie & Xie, Li, 2012. "Strategic Asset Allocation for Central Bank’s Management of Foreign Reserves: A new approach," MPRA Paper 43654, University Library of Munich, Germany.
    16. Flori, Andrea, 2019. "News and subjective beliefs: A Bayesian approach to Bitcoin investments," Research in International Business and Finance, Elsevier, vol. 50(C), pages 336-356.
    17. Dimitris Bertsimas & Vishal Gupta & Ioannis Ch. Paschalidis, 2012. "Inverse Optimization: A New Perspective on the Black-Litterman Model," Operations Research, INFORMS, vol. 60(6), pages 1389-1403, December.
    18. Yugu Xiao & Emiliano A. Valdez, 2015. "A Black-Litterman asset allocation model under Elliptical distributions," Quantitative Finance, Taylor & Francis Journals, vol. 15(3), pages 509-519, March.

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