The Black-Litterman model

Abstract

The aim of this thesis is to review the Black-Litterman model and some of its predecessors. After reviewing the models, we will try to compare the effectiveness of them by running a MATLAB simulation.\\ In the first part, we will reconstruct and comment on the Markowitz model. These comments show that although the theoretical approach is solid, the model does not survive empirical testing. The thesis then continues to review the Capital Asset Pricing Model and its flaws. The harsh assumptions simplify the model too much, lowering the quality of the model. In the next part the thesis reviews the Black-Litterman model and it flaws. There are some fundamental issues that are needed to simplify the model, but that may make this model unfit for real world use. These flaws however, have a more general source such that these flaws are applicable to all models that are based on mean-variance analysis. We then compare these derived models by using a MATLAB simulation for 19 stocks.