Practical Applications of The Black–Litterman Approach and Views from Predictive Regressions: Theory and Implementation

Abstract

Investors value the Black–Litterman approach for its ability to take into account their subjective views in determining portfolio construction. But implementation can be tricky, as investors struggle to quantify their hunches. In The Black–Litterman Approach and Views from Predictive Regressions: Theory and Implementation, KatarinaLucivjanskaj and Alois Geyer augment the Black–Litterman approach with predictive regression. “We can use predictors such as a price-to-earnings ratio or dividend yield to form our subjective views.” explains Lucivjanska. The authors study more than 40 years of data from seven countries to understand the predictive power of p/e and dividend yield for the various markets to create informed subjective views to guide asset allocation. Given a suitable predictor, they find that a combination of an equilibrium model with predictive regression, followed by subjective analysis, can lead to enhanced results.