Incorporating Trading Strategies in the Black-Litterman Framework

The simplicity and the intuitive appeal of portfolio construction using modern portfolio theory have attracted significant attention both in academia and in practice. Yet, despite considerable effort it took many years until portfolio managers started using modern portfolio theory for managing real money. Unfortunately, in real world applications there are many problems associated with it, and portfolio optimization is still considered by many practitioners to be difficult to apply. Introducing a simple crosssectional momentum strategy, we show how we can combine this strategy with market equilibrium using the Black-Litterman model in the mean-variance framework to rebalance the portfolio on a monthly basis. TOPICS:Portfolio construction, portfolio theory, performance measurement