FRM Part II · FRM Exam Part II · Portfolio Construction

A manager sets the Black-Litterman view uncertainty matrix Omega proportional to P(tau Sigma)P', where P is the view pick matrix. Two views are held: one on a single asset and one on a spread of two assets. Which statement best describes the effect of this specification?

Making Omega proportional to P(tau Sigma)P' gives each view the same relative confidence versus the prior, so view variance scales with the prior variance of the view portfolio. Views on riskier portfolios therefore carry larger absolute uncertainty, not identical variances.

1. AThe posterior ignores the views because Omega is tied to the prior covariance
2. BThe views carry the same confidence level relative to the prior as measured by the prior variance of the view portfolios, so views on riskier portfolios are allowed larger deviationsCorrect
3. CAll views receive identical absolute variances regardless of the assets involved
4. DThe posterior equals the view-implied returns exactly