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FRM Part II · FRM Exam Part II · Portfolio Construction

A risk manager reviews a Black-Litterman portfolio. The manager held a single view that Asset A will outperform Asset B, with moderate confidence, and A and B are highly positively correlated in the prior covariance matrix. Which outcome is most consistent with the model's behavior?

Asset A's expected return rises, Asset B's falls, and returns of correlated assets also shift. Because the Bayesian update runs through the covariance matrix, a single relative view spreads its influence across the whole return vector rather than affecting only the two named assets.

  1. AOnly Asset A's expected return changes; Asset B's is unchanged
  2. BAsset A's expected return rises and Asset B's falls, and other correlated assets' returns also shiftCorrect
  3. CAll asset returns rise by the same amount
  4. DNo return changes because the view is relative, not absolute

Explanation

A relative view is a bet on the spread. The posterior update uses the covariance matrix, so A's return rises, B's falls, and assets correlated with A or B also adjust. Views therefore spread across the whole return vector, which is why the model gives diversified tilts. A relative view does change returns.

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