Copula-Based Black-Litterman Portfolio Optimization

32 Pages Posted: 24 Nov 2020

See all articles by Maziar Sahamkhadam

Maziar Sahamkhadam

Linnaeus University

Andreas Stephan

Linnaeus University

Ralf Östermark

School of Business and Economics - Åbo Akademi University

Date Written: September 21, 2020

Abstract

We extend the Black-Litterman (BL) approach to incorporate tail dependency in portfolio optimization and estimate the posterior joint distribution of returns using vine copulas. Our novel copula-based BL (CBL) model leads to flexibility in modeling returns symmetric and asymmetric multivariate distribution from a range of copula families. Based on a sample of 30 stocks, we evaluate the performance of the suggested CBL approach and portfolio optimization technique using out-of-sample back-testing. Our empirical analysis and robustness check indicate better performance for the CBL portfolios in terms of lower tail risk and higher risk-adjusted returns, compared to the benchmark strategies.

Keywords: Finance, portfolio optimization, Black--Litterman framework, truncated regular vine copula, tail constraints, conditional value-at-risk

JEL Classification: G21

Suggested Citation

Sahamkhadam, Maziar and Stephan, Andreas and Östermark, Ralf, Copula-Based Black-Litterman Portfolio Optimization (September 21, 2020). Available at SSRN: https://ssrn.com/abstract=3708097 or http://dx.doi.org/10.2139/ssrn.3708097

Maziar Sahamkhadam

Linnaeus University ( email )

Växjö, S-35195
Sweden

Andreas Stephan (Contact Author)

Linnaeus University ( email )

Universitetsplatsen 1
Växjö, 351 95
Sweden

Ralf Östermark

School of Business and Economics - Åbo Akademi University ( email )

Henriksgatan 7
Abo, Turku FIN-20500
Finland

HOME PAGE: http://users.abo.fi/rosterma/

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