Enhancing investment performance of Black-Litterman model with AI hybrid system: Can it be done?

Abstract

The B-L (Black-Litterman) model combines the subjective views of investors with the market's historical equilibrium return through the Bayesian theorem. This approach somewhat compensates for the limitations of the Mean-Variance model, making the asset allocation model attract significant attention. However, due to many investors lacking ample investment experience, they might struggle to provide appropriate subjective views. To address this issue, an Iaah (Industry Asset Allocation Hybrid) system based on the B-L model is proposed. First, a combined model is constructed, which simulates view return vectors and solves the problem of inaccurate view quantification. Then, the Iaah system introduces a dynamic condition correlation algorithm to optimize inherent parameters and explores asset allocation results in the time-varying effects. Next, it expands the types of objective functions and improves the deficiency of only considering the return and variance while ignoring the downside risk. Finally, based on a variety of performance metrics, the Iaah system is evaluated from multiple perspectives to test its practical value. The experiment results with the daily data of 10 SSE (Shanghai Stock Exchange) industry indexes show that the proposed system not only realizes the diversified allocation of industry assets and enhances the investment performance, but also exhibits strong robustness against changes in subjective parameters. It is conducive to managing personal wealth and achieving preservation and appreciation.