CAPM and Black-Litterman Flashcards
Describe the CAPM assumptions.
- Perfect markets, i.e. no taxes, no borrowing constriants and perfect competition between investors.
- Investors have common characteristics, i.e. same holding period, max expected utility, same beliefs.
What is one important implication of the CAPM assumptions?
If all investors are the same, they solve the same mathematical problem and all have the same allocation. Thus the global risk allocation is that of the tangency portfolio.
What is the formula for Beta in the CAPM?
The ratio of Covariance between excess returns of the asset and excess returns of the market, over the variance of the excess returns of the market.
What is the Capital Markets Line?
It is the Capital Allocation Line with the market portfolio as the portfolio of risky assets.
What are two ways to reduce the impact of estimation error on portfolio optimization?
- We can deduct benchmark weights of each asset to the optimization procedure such that the optimal weights are closer to real life benchmark values.
- Mixed estimation: incorporate prior private beliefs about returns in the optimization procedure.
What is the formula for optimal weights in the Black Litterman model?
Incorporating uncertainty estimation of the Covariance Matrix, what is the formula for optimal weights?
Think about the Black-Litterman Model. Write the following private views in matrix form: You have for assets. You believe that the first one will have a mean excess return of 2% and the second will outperform the third by 3%.
What is the formula for expected returns after incorporatin private views?
What is the Matrix Inverse(M) in the context of the Black Litterman framework of private views.
What is the formula for the covariance matrix after incorporating private views in the Black Litterman framework?
