The Black-Litterman Model: The Definition of Views Based On Volatility Forecasts

30 Pages Posted: 22 Feb 2016

See all articles by Andi Duqi

Andi Duqi

University of Bologna - Department of Management; University of Bologna - Yunus Social Business Centre

Leonardo Franci

Independent

Giuseppe Torluccio

University of Bologna - Department of Management; Università degli studi di Modena e Reggio Emilia (UNIMORE) - Center for Research in Banking and Finance (CEFIN)

Date Written: February 6, 2014

Abstract

This paper aims to implement a portfolio optimization strategy considering two fundamental aspects: the empirical regularities observed in the time series of stock returns, and the views of portfolio managers about these regularities. From an analytical point of view, all the results are examined through an application of the approach of Black and Litterman (1992). In particular, our innovative contribution to the extant literature is the use of the EGARCH-M (exponential GARCH-in-mean) model to formulate a volatility forecast of returns used as an input for determining some subjective views to be included in the Black- Litterman model. The bets of the portfolio manager thus enter into the mechanism of generating expectations about the vector of returns, revealing information about investment opportunities. The results show that the Black-Litterman model using the EGARCH inputs produces allocations with potentially sizeable benefits. Greater reliance on the implied BL excess returns, in setting the allocations, result in higher risk-return ratio.

Keywords: Tactical Asset Allocation, EGARCH, Black-Litterman model

JEL Classification: C32, C53, G11, G15

Suggested Citation

Duqi, Andi and Franci, Leonardo and Torluccio, Giuseppe, The Black-Litterman Model: The Definition of Views Based On Volatility Forecasts (February 6, 2014). Available at SSRN: https://ssrn.com/abstract=2736053 or http://dx.doi.org/10.2139/ssrn.2736053

Andi Duqi (Contact Author)

University of Bologna - Department of Management ( email )

Piazza Scaravilli 1
Bologna, Bologna 40126
Italy

University of Bologna - Yunus Social Business Centre

Piazzale della Vittoria 15
Forlì, FC 47122
Italy

Leonardo Franci

Independent ( email )

Giuseppe Torluccio

University of Bologna - Department of Management ( email )

via Capo di Lucca 34
40126 Bologna
Italy
+39 051 2098085 (Phone)

HOME PAGE: http://WWW.SA.UNIBO.IT

Università degli studi di Modena e Reggio Emilia (UNIMORE) - Center for Research in Banking and Finance (CEFIN) ( email )

via Berengario 51
Modena, modena I-41100
Italy

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