On the Bayesian Interpretation of Black-Litterman
European Journal of Operational Research, Volume 258, Issue 2, 16 April 2017, Pages 564-572
22 Pages Posted: 17 Oct 2016 Last revised: 1 Dec 2017
Date Written: October 16, 2016
We present the most general model of the type considered by Black and Litterman (1991) after fully clarifying the duality between Black-Litterman optimization and Bayesian regression. Our generalization is itself a special case of a Bayesian network or graphical model. As an example, we work out in full detail the treatment of views on factor risk premia in the context of APT. We also consider a more speculative example in which the portfolio manager specifies a view on realized volatility by trading a variance swap.
Keywords: Black-Litterman, Portfolio Optimization, APT, Bayesian statistics
JEL Classification: G11
Suggested Citation: Suggested Citation