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

See all articles by Petter N. Kolm

Petter N. Kolm

New York University (NYU) - Courant Institute of Mathematical Sciences

Gordon Ritter

New York University (NYU) - Courant Institute of Mathematical Sciences; City University of New York (CUNY) - Weissman School of Arts and Sciences; Rutgers, The State University of New Jersey - Financial Statistics & Risk Management; New York University (NYU) - NYU Tandon School of Engineering

Date Written: October 16, 2016

Abstract

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

Kolm, Petter N. and Ritter, Gordon, On the Bayesian Interpretation of Black-Litterman (October 16, 2016). European Journal of Operational Research, Volume 258, Issue 2, 16 April 2017, Pages 564-572, Available at SSRN: https://ssrn.com/abstract=2853158

Petter N. Kolm

New York University (NYU) - Courant Institute of Mathematical Sciences ( email )

251 Mercer Street
New York, NY 10012
United States

Gordon Ritter (Contact Author)

New York University (NYU) - Courant Institute of Mathematical Sciences ( email )

New York University
251 Mercer Street
New York, NY 10012
United States

City University of New York (CUNY) - Weissman School of Arts and Sciences ( email )

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New York, NY 10010
United States

Rutgers, The State University of New Jersey - Financial Statistics & Risk Management ( email )

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479 Hill Center, Busch Campus
Piscataway, NJ 08854
United States

New York University (NYU) - NYU Tandon School of Engineering ( email )

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Brooklyn, NY 11201
United States

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