Optimisation of Asset Allocation based on Black-Litterman
Project Description
The classical approach of portfolio theory is almost exclusively based on the work by Harry Markowitz in which a double-sides objective is defined: maximisation of expected portfolio return by simultaneously minimising portfolio risk. As far as it comes to academic literature, the principles of modern portfolio theory are playing a major role and are generally accepted by theoreticians. However, the impact on the financial world is far less significant, when leaving aside the implementation of multiple constraints, and the respective concepts often disregarded due to its limitations when applied in the real financial world. The main short-comings are agreed to be its high portfolio sensitivity towards estimation errors (returns, volatility and correlations are traditionally estimated based on historical data) and the large impact of interim return alterations on the portfolio composition, which leads to extreme weight allocations, an increased number of shifts between the assets and thereby ultimately increasing transaction costs.
Fisher Black and Robert Litterman have developed the so called Black-Litterman approach in 1991 to improve the applicability of quantitative portfolio optimisation in practice. The approach allows for the flexible specification of a random number of stock recommendations and calculates in combination with strategic reference portfolios the new optimal portfolio weights. In fact, this approach is a successful realisation of Markowitz proposal to combine quantitative computed expected returns with subjective forecasts.
This cumulative dissertation aims at further establishing the Black-Litterman model (BL) by applying it to three special cases and thereby shedding more light on the characteristics of the model and its possibilities. At the same time each paper is assigned a specific research question, which the author wants to answer. All of the papers are focusing on answering research question in the field of financial economics.
Fisher Black and Robert Litterman have developed the so called Black-Litterman approach in 1991 to improve the applicability of quantitative portfolio optimisation in practice. The approach allows for the flexible specification of a random number of stock recommendations and calculates in combination with strategic reference portfolios the new optimal portfolio weights. In fact, this approach is a successful realisation of Markowitz proposal to combine quantitative computed expected returns with subjective forecasts.
This cumulative dissertation aims at further establishing the Black-Litterman model (BL) by applying it to three special cases and thereby shedding more light on the characteristics of the model and its possibilities. At the same time each paper is assigned a specific research question, which the author wants to answer. All of the papers are focusing on answering research question in the field of financial economics.
