Portfolio construction and empirical testing of Black
Litterman model
Gianpaolo D’Orazio
Abstract
The main subject of this thesis is portfolio construction and Black-Litterman estimation model. In the
first chapter, I will analyse gradually all the techniques which are necessary to build a reasonable
portfolio. The starting point is asset allocation; it follows risk and correlation matrix, then
Markowitz’s mean-variance optimization with its weaknesses and strengths.
The unreason ability of simple Markowitz’s optimization will be shown and the model will be first
improved by intragroup constraints, then by a resampling technique, then by a Bayesian estimation
method, the Black-Litterman model.
The second chapter deals with calibrating the Black-Litterman model I order to overcome the
problems arisen by the difficulty in its parameters’ estimation.
Finally, Black-Litterman estimation model will be compared with resampling and afterwards with
infragroup constraint technique in order to elect the best model available.
Key words: Strategic asset allocation, risk and correlation measures, portfolio optimization,
Black-Litterman model, resampling technique, infragroup constraints