Black-Litterman is an asset allocation model that allows portfolio managers to incorporate views into CAPM equilibrium returns and to create more diversified portfolios than those generated by traditional mean-variance optimization.
Developed by Fisher Black and Bob Litterman in the 1990s, the Black-Litterman model uses mixed estimation techniques to combine the market equilibrium vector of expected returns with an investor-specific, usually Bayesian-derived, vector to form a new, posterior estimate of expected returns. The final vector of expected returns is assumed to have a probability distribution of the product of two multivariate normal distributions.
To overcome the limitations in modern portfolio theory, many asset management companies have adopted the Black-Litterman model to implement practical asset allocation models.
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