The Black-Litterman Model in Detail

Abstract:     
This paper provides a clear and complete explanation of the Black-Litterman model. Drawing from the key papers in the literature it provides a complete derivation of the Black-Litterman model from Theil's Mixed Estimation Model as described in Black and Litterman's original paper. We then show the derivation from Bayesian Theory for comparison. We discuss several of the key papers from the literature. For each paper we provide a complete derivation and explanation of the results, along with a worked example where possible. Where relevant we compare the results from the various papers. The parameters of the model are considered along with information on their computation or calibration. Several methods of measuring or calibrating the results of the model are also presented.

Keywords: quantitative portfolio management, asset allocation, black-litterman, mixed-estimation

JEL Classifications: C11, G11

Working Paper Series