Behavioral Finance and its Implication in the use of the Black-Litterman Model

Charlotta Mankert and Michael Seiler ()

Journal of Real Estate Portfolio Management, 2012, vol. 18, issue 1, 99-121

Abstract: This article discusses the behavioral implications of the Black-Litterman model. In behavioral finance, the utility function of the investor is reference-based, and investors estimate losses and gains in relation to this benchmark. Implications drawn from past research within the field indicate and explain why the portfolio output given by the Black-Litterman model appears more intuitive to fund managers than portfolios generated by the Markowitz model. Another feature of the Black-Litterman model is that the user assigns levels of confidence associated with each asset view in the form of confidence intervals. People are overconfident in financial decision-making, particularly when stating confidence intervals, which is particularly problematic for this model. Hence implications from research regarding overconfidence do not favor the use of confidence levels when weighting portfolios.

Date: 2012
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DOI: 10.1080/10835547.2012.12089911

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