An Empirical Evaluation of the Black-Litterman Approach to Portfolio Choice
37 Pages Posted: 12 Mar 2011 Last revised: 26 Oct 2012
Date Written: October 18, 2012
We evaluate the Black-Litterman equilibrium model approach to portfolio choice. We quantify the improvement in portfolio performance of a privately informed investor who learns from market prices over an equally informed, but dogmatic investor who only uses private information. We extend the approach to any linear multi-factor asset pricing model (e.g. ICAPM) to examine how learning from prices using different equilibrium models affects portfolio performance. We find that even a misspecified asset-pricing model can improve portfolio performance when private signals are not extremely precise. As we increase the noise in private information, learning from prices is initially harmful and gradually becomes more beneficial.
Keywords: Bayesian portfolio choice, learning from prices, Black-Litterman
JEL Classification: G11, D83
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