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Asset Management

Asset Management. Lecture 9. Outline for today. Black-litterman model and sensitivity in confidence Treynor-Black vs Black-Litterman Value of active management. The Black-Litterman Model. Step 1: Estimate the covariance matrix from historical data Step 2: Determine a baseline forecast

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Asset Management

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  1. Asset Management Lecture 9

  2. Outline for today • Black-litterman model and sensitivity in confidence • Treynor-Black vs Black-Litterman • Value of active management

  3. The Black-Litterman Model Step 1: Estimate the covariance matrix from historical data Step 2: Determine a baseline forecast Step 3: Integrating the manager’s private views Step 4: Developing revised (posterior) expectations Step 5: Apply portfolio optimization

  4. Sensitivity in confidence level

  5. Figure 27.5 Sensitivity of Black-Litterman Portfolio Performance to Confidence Level (view is correct)

  6. Treynor-Black vs Black-Litterman

  7. The BL Model as Icing on the TB Cake • Suppose that you have two portfolios—one for the US and one for Europe • The model would be run as two separate divisions • Each division would compile values of alpha relative to their own passive portfolio • Portfolios need to be optimized separately • Relative performance of the two markets can be expected to add information to the independent macro forecasts for the two economies

  8. The BL Model as Icing on the TB Cake • Use BL to include forecasts from comparative economic and international finance analyses • Replace TB alpha with BL views • Example: assume only one stock in the active portfolio • Alpha, beta, E(Rm), var(Rm), var(e)

  9. The BL Model as Icing on the TB Cake • Use BL to include forecasts from comparative economic and international finance analyses • Input list for BL model

  10. The BL Model as Icing on the TB Cake • Use BL to include forecasts from comparative economic and international finance analyses • Calculate the conditional expected return will give you the same results as from the TB model: • The realized abnormal return of time T • The precision of record, t<T • Adjust

  11. The BL Model as Icing on the TB Cake • The BL model could be viewed as a generalization of the TB model • Differences?

  12. Treynor-Black vs Black-Litterman

  13. Value of Active Management Remember f is in addition to what an index fund would charge. • Model for estimation of potential fees • Kane, Marcus, and Trippi (JPM, 1999) • The percentage fee, f, that investors would be willing to pay for active services • Source of the power of the active portfolio • the squared information ratios

  14. Concluding Remarks The gap between theory and practice has been narrowing in recent years TB model is sensitive to large alpha values BL model relies on the “confidence” level which is often ambiguous.

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