Black-Litterman and Beyond: The Bayesian Paradigm in Investment Management

Abstract

The Black-Litterman model is one of the most popular models in quantitative finance, with numerous theoretical and practical achievements. From the standpoint of investment theory, the Black-Litterman model allows a seamless incorporation of Bayesian statistics into the portfolio optimization process. From a practical standpoint, it provides portfolio managers with a structured approach to express subjective views, thereby freeing their investment processes from a total reliance on backward-looking historical data. In this article, the authors provide an overview of the original Black-Litterman model and its various extensions and enhancements addressing issues in real-world trading and investment management.

Keywords: Bayesian statistics, Black-Litterman, Factor investing, Investment management, Portfolio optimization, Portfolio theory, Risk premia, Robust portfolio management, Trading, Transaction costs, Views

JEL Classification: G11, C61, C11