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FRM Part II · FRM Exam Part II · Portfolio Construction

A manager has a single absolute view on Asset A and uses Black-Litterman. Equilibrium return of A is 6%, the view is 10%, the prior variance of A's mean is 0.0004 (2%^2), and view variance is 0.0004. Assume only A is considered and the view is on A directly. What is the posterior expected return of A?

The posterior is 8%. The prior and the view have equal variance, so they get equal precision weights of 50% each, giving the average of the 6% equilibrium return and the 10% view. Selecting 10% would ignore uncertainty in the view.

  1. A6%
  2. B8%Correct
  3. C10%
  4. D7%

Explanation

Posterior is a precision-weighted average. Precisions are 1/0.0004 for both, so weights are 50% each. Posterior = 0.5*6% + 0.5*10% = 8%. Choosing 10% ignores the prior uncertainty.

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