Black-Litterman

In this framework, the expected returns are viewed as a blend of capital markets information and a specific set of investor views. Two often-cited drawbacks to the classical mean-variance model are its instability (small changes in input parameters may lead to large changes in allocations) and its lack of flexibility to incorporate investors’ insights.

Intuitively, portfolio managers should take risk where they have views and hence, they should take the most risk where they have the strongest views. In response to these criticisms, Black and Litterman improved the stability of the optimization process by combining active investment decisions with the market prior using Bayesian techniques.