Question

Q. what is the difference between Black-litterman and Stutzer’s 2004 optimisation approach ?

Answer 1

The Black-Litterman model enables investors to combine their unique views regarding the performance of various assets with the market equilibrium in a manner that results in intuitive, diversified portfolios. This paper consolidates insights from the relatively few works on the model and provides step-by-step instructions that enable the reader to implement this complex model. A new method for controlling the tilts and the final portfolio weights caused by views is introduced. The new method asserts that the magnitude of the tilts should be controlled by the user-specified confidence level based on an intuitive 0% to 100% confidence level. This is an intuitive technique for specifying one of most abstract mathematical parameters of the Black-Litterman model. The Black-Litterman (BL) Model is an analytical tool used by portfolio managers to optimize asset allocation within an investor’s risk tolerance and market views. Global investors, such as pension funds and insurance companies, need to decide how to allocate their investments across different asset classes and countries. The BL model helps them do this by generating expected returns of hypothetical portfolios, taking into account the investor’s view.ging the issue of model estimation error, which is problematic when generating expected return outcomes.

Stutzer’s 2004 optimisation approach provides an alternative behavioral foundation for an investor's use of power utility in the objective function and its particular risk aversion parameter. The foundation is grounded in an investor's desire to minimize the objective probability that the growth rate of invested wealth will not exceed an investor-selected target growth rate. Large deviations theory is used to show that this is equivalent to using power utility, with an argument that depends on the investor's target, and a risk aversion parameter determined by maximization. As a result, an investor's risk aversion parameter is not independent of the investment opportunity set, contrary to the standard model assumption.