Mathematical Derivations and Practical Implications for the Use of the Black-Litterman Model

Abstract

Executive Summary. In this article, the financial portfoliomodel often referred to as the Black-Littermanmodel is described, and then mathematically derived, usinga sampling theoretical approach. This approach generatesa new interpretation of the model and gives aninterpretable formula for the mystical parameter, τ, theweight-on-views. The practical implications of the modelare discussed, along with how portfolio fund managersshould arrive at model input values and what considerationmust be weighted beforehand.