The augmented Black--Litterman model: a ranking-free approach to factor-based portfolio construction and beyond

Wing Cheung

Quantitative Finance, 2013, vol. 13, issue 2, 301-316

Abstract: The Fama and French factor-ranking approach (1992, 1993, etc.) has been extensively applied in quantitative fund management. However, this approach suffers from hidden factor view, information inefficiency, etc. issues. Based on the Black--Litterman model (1992; as explained in Cheung 2010b), we develop a technique that endogenizes the ranking process and elegantly resolves these issues. This model explicitly seeks forward-looking factor views and smoothly blends them to deliver robust allocation to securities. Our numerical experiments show this is an intuitive and practical framework for factor-based portfolio construction, and beyond. This article features: (1) a new and unified framework for strategy combination, factor mimicking and security-specific bets; (2) an elegant and ranking-free approach to factor style construction; (3) worked examples based on the FTSE EUROTOP 100 universe; (4) insight into the classic issue of confidence parameter setting; and (5) implementation guidance in an appendix.

Date: 2013
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Citations: View citations in EconPapers (5)

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DOI: 10.1080/14697688.2012.714902

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