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Abstract

Quantitative asset allocation models have not played the important role they should in global portfolio management. A good part of the problem is that such models are difficult to use and tend to result in portfolios that are badly behaved.

Consideration of the global CAPM equilibrium can significantly improve the usefulness of these models. In particular, equilibrium returns for equities, bonds and currencies provide neutral starting points for estimating the set of expected excess returns needed to drive the portfolio optimization process. This set of neutral weights can then be tilted in accordance with the investor's views.

If the investor has no particular views about asset returns, he can use the neutral values given by the equilibrium model. If the investor does have one or more views about the relative performances of assets, or their absolute performances, he can adjust equilibrium values in accordance with those views. Furthermore, the investor can control how strongly a particular view influences portfolio weights, in accordance with the degree of confidence with which he holds the view.

About the Author(s)

Fischer Black
Robert Litterman PHD

Robert B. Litterman is a founding partner and chair of the risk committee at Kepos Capital, a systematic global macro firm. Previously, he served in research, risk management, investment, and thought leadership roles at Goldman Sachs & Co., where he also oversaw the Quantitative Investment Strategies group in the asset management division. Dr. Litterman also served as one of three external advisers to Singapore's Government Investment Corporation. He was named a partner of Goldman Sachs and became head of the firm-wide risk function and also served as co-head of the fixed-income research and model development group with Fischer Black. Dr. Litterman has published a number of groundbreaking papers in asset allocation and risk management and is the co-developer of the Black Litterman global asset allocation model, a key tool in investment management. He has coauthored several books, including The Practice of Risk Management and Modern Investment Management: An Equilibrium Approach. Dr. Litterman serves on a number of boards, including Commonfund, the Options Clearing Corporation, Resources for the Future, the Robert Wood Johnson Foundation, the Alfred P. Sloan Foundation, and the World Wildlife Fund. He holds a BS in human biology from Stanford University and a PhD in economics from the University of Minnesota.