Book contents
- Frontmatter
- Dedication
- Contents
- List of figures
- List of tables
- Acknowledgements
- Part I Our approach in its context
- Part II Dealing with extreme events
- Part III Diversification and subjective views
- Part IV How we deal with exceptional events
- Part V Building Bayesian nets in practice
- Part VI Dealing with normal-times returns
- Part VII Working with the full distribution
- Part VIII A framework for choice
- Part IX Numerical implementation
- Part X Analysis of portfolio allocation
- Appendix I The links with the Black–Litterman approach
- References
- Index
Appendix I - The links with the Black–Litterman approach
Published online by Cambridge University Press: 18 December 2013
- Frontmatter
- Dedication
- Contents
- List of figures
- List of tables
- Acknowledgements
- Part I Our approach in its context
- Part II Dealing with extreme events
- Part III Diversification and subjective views
- Part IV How we deal with exceptional events
- Part V Building Bayesian nets in practice
- Part VI Dealing with normal-times returns
- Part VII Working with the full distribution
- Part VIII A framework for choice
- Part IX Numerical implementation
- Part X Analysis of portfolio allocation
- Appendix I The links with the Black–Litterman approach
- References
- Index
Summary
In this appendix we look at how we can reconcile our approach with the Black–Litterman model. Given the subjective nature of both approaches, it is useful to present them using a unified ‘language’. In particular, the Black–Litterman approach can be used (admittedly, in a rather reductive manner) as a regularization device to tame the instabilities in allocations from which the Markowitz model notoriously suffers. We show that the Black-Litterman approach can be married to the Bayesian-net construction that we propose, and that also in this marriage it can play a ‘regularization’ function. In Chapter 29 (see Section 29.2 in particular) we discussed whether this way of achieving a greater stability for the allocation weights is desirable or not.
The Black–Litterman ‘regularization’
We provided in Chapter 9 what we called a somewhat ‘tendentious’ presentation of the Black–Litterman approach – where, when we say ‘tendentious’, we simply mean that we gave a presentation explicitly tailored to highlighting two particular messages out of the many that could be extracted from the approach.
(i) The first ‘message’ is that, as the Black–Litterman approach naturally incorporates subjective views into its set-up, it is germane in spirit, if not in implementation, to our view of the world. Therefore combining Black–Litterman with Bayesian nets is a natural logical step. We show in the rest of this chapter how this can be done.
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- Portfolio Management under StressA Bayesian-Net Approach to Coherent Asset Allocation, pp. 465 - 470Publisher: Cambridge University PressPrint publication year: 2014