Mathematical Derivations and Practical Implications for the Use of the Black-Litterman Model

Abstract

In this article, the financial portfolio model often referred to as the Black-Litterman model is described, and then mathematically derived, using a sampling theoretical approach. This approach generates a new interpretation of the model and gives an interpretable formula for the mystical parameter, t, the weight-on-views. We then discuss practical implications of the model and explain how actual portfolio fund managers should arrive at model input values and what consideration must be weighted beforehand.

Keywords: Black-Litterman, weight-on-views, derivation