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The Black-Litterman Model: mathematical and behavioral finance approaches towards its use in practice
KTH, School of Industrial Engineering and Management (ITM), Industrial Economics and Management (Dept.).
2006 (English)Licentiate thesis, monograph (Other scientific)
Abstract [en]

The financial portfolio model often referred to as the Black-Litterman model is analyzed using two approaches; a mathematical and a behavioral finance approach. After a detailed description of its framework, the Black-Litterman model is derived mathematically using a sampling theoretical approach. This approach generates a new interpretation of the model and gives an interpretable formula for the mystical parameter τ, the weight-on-views. Secondly, implications are drawn from research results within behavioral finance. One of the most interesting features of the Black-Litterman model is that the benchmark portfolio, against which the performance of the portfolio manager is evaluated, functions as the point of reference. According to behavioral finance, the actual utility function of the investor is reference-based and investors estimate losses and gains in relation to this benchmark. Implications drawn from research results within behavioral finance indicate and explain why the portfolio output given by the Black-Litterman model appears more intuitive to fund managers than portfolios generated by the Markowitz model. Another feature of the Black-Litterman model is that the user assigns levels of confidence to each asset view in the form of confidence intervals. Research results within behavioral finance have, however, shown that people tend to be badly calibrated when estimating their levels of confidence. Research has shown that people are overconfident in financial decision-making, particularly when stating confidence intervals. This is problematic. For a deeper understanding of the use of the Black-Litterman model it seems that we should turn to those financial fields in which social and organizational context and issues are taken into consideration, to generate better knowledge of the use of the Black-Litterman model.

Place, publisher, year, edition, pages
Stockholm: KTH , 2006. , 111 p.
Series
Trita-IEO, ISSN 1100-7982 ; R 2006:13
Keyword [en]
Black-Litterman Model, Portfolio Management, Portfolio Theory, Portfolio Models, Behavioral Finance
National Category
Economics and Business
Identifiers
URN: urn:nbn:se:kth:diva-3997ISBN: 91-7178-397-0 (print)OAI: oai:DiVA.org:kth-3997DiVA: diva2:10311
Presentation
2006-06-15, Aud Albert Danielsson, SingSing, Lindstedtsvägen 30, Stockholm, 10:30
Opponent
Supervisors
Note
QC 20101119Available from: 2006-06-01 Created: 2006-06-01 Last updated: 2010-11-19Bibliographically approved

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CiteExportLink to record
Permanent link

Direct link
Cite
Citation style
  • apa
  • harvard1
  • ieee
  • modern-language-association-8th-edition
  • vancouver
  • Other style
More styles
Language
  • de-DE
  • en-GB
  • en-US
  • fi-FI
  • nn-NO
  • nn-NB
  • sv-SE
  • Other locale
More languages
Output format
  • html
  • text
  • asciidoc
  • rtf