Implementing Black-Litterman Using an Equivalent Formula and Equity Analyst Target Prices

Posted: 31 Mar 2012 Last revised: 4 Feb 2015

See all articles by Leon Chen

Leon Chen

Minnesota State University, Mankato

Zhi Da

University of Notre Dame - Mendoza College of Business

Ernst Schaumburg

Federal Reserve Banks - Federal Reserve Bank of New York

Date Written: February 3, 2015

Abstract

We examine an alternative and equivalent Black and Litterman [1992] formula using classical multivariate analysis which is easier to interpret and which allows more general view formulations than the original formula. Speci fically, the equivalent formula provides more intuitive explanation under the limiting case of deterministic views, and it is also easier to show that the resulting optimal portfolio as a combination of the market portfolio and a long-short view portfolio. The equivalent formula also allows for more convenient empirical implementations when views and expected return priors are correlated. We then use a numerical example to illustrate the equivalent formula, and also implement the formula in an optimal asset allocation setting using equity analysts' 12-month ahead target price forecasts for the period of 1999-2010. We show that the optimal portfolio outperforms the market (S&P 500) and this result is robust across diff erent time periods and model parameter choices.

Keywords: Asset allocation, Black-Litterman model, Target price

JEL Classification: G12

Suggested Citation

Chen, Leon and Da, Zhi and Schaumburg, Ernst, Implementing Black-Litterman Using an Equivalent Formula and Equity Analyst Target Prices (February 3, 2015). Available at SSRN: https://ssrn.com/abstract=2031172 or http://dx.doi.org/10.2139/ssrn.2031172

Leon Chen (Contact Author)

Minnesota State University, Mankato ( email )

150 Morris Hall
Mankato, MN Minnesota 56001
United States

Zhi Da

University of Notre Dame - Mendoza College of Business ( email )

Notre Dame, IN 46556-5646
United States

Ernst Schaumburg

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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