The Black–Litterman Model

Michael Donadelli, Michele Costola and Ivan Gufler
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Michael Donadelli: University of Brescia
Michele Costola: Ca’ Foscari University of Venice
Ivan Gufler: Luiss Guido Carli

Chapter 8 in Essentials of Financial Economics, 2025, pp 203-222 from Springer

Abstract: Abstract Markowitz’s MPT advises investors to balance risky assets (market portfolio) with a risk-free asset based on their risk tolerance, assuming uniform expectations about returns, risks, and correlations. In reality, investors have diverse views and risk preferences, challenging the notion of a universal optimal portfolio. MPT also assumes rational behavior and common knowledge of this rationality among all market participants. To address these limitations, models like Black-Litterman refine asset allocation by incorporating subjective investor views alongside historical data, improving portfolio diversification and adaptability. Unlike MPT, which relies solely on historical returns, the Black-Litterman model blends market equilibrium with individual forecasts, leading to more stable and realistic asset allocations.

Date: 2025
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DOI: 10.1007/978-3-031-86189-5_8

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