Reconstructing the Black-Litterman Model

Abstract

During the past 20 years several urban legends about the Black-Litterman model have appeared in the literature. These urban legends lie in wait for authors who do not consider the canon of Black-Litterman literature written by the primary authors of the model. Generally these urban legends were created when authors attempted to simplify the model or introduce extensions to the model which they felt were more tractable than the canonical model. At times other authors have used these urban legends attempting to convince investors that the Black-Litterman model does not have a rigorous theoretical basis and should not be used. In this paper we will provide a short review of the Black-Litterman model as provided by the original authors of the model. We will then provide a taxonomy/literature survey over several important papers in the Black-Litterman literature. Finally we will address the urban legends in detail.