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FRM Part II · FRM Exam Part II · Portfolio Construction

A portfolio manager uses the Black-Litterman model. In the absence of any investor views, what does the model's posterior expected return vector equal?

With no views, the Black-Litterman posterior equals the prior, which is the equilibrium returns implied by market capitalization weights through reverse optimization. Without views there is no information to update the prior, and historical sample means are not part of the starting point.

  1. AThe implied equilibrium returns derived from market capitalization weightsCorrect
  2. BThe historical sample mean returns of each asset
  3. CThe risk-free rate for every asset
  4. DThe returns that maximize the Sharpe ratio for the sample covariance matrix

Explanation

Black-Litterman starts from a prior equal to the equilibrium (reverse-optimized) returns implied by market-cap weights. With no views, there is no new information to update the prior, so the posterior equals the prior. Sample means are not used as the prior.

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