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FRM Part II · FRM Exam Part II · Portfolio Construction

In a Black-Litterman setting with a single view, an analyst increases the confidence in the view (reducing the variance of the view error term, Omega) while leaving everything else unchanged. What is the effect on the posterior expected returns and resulting weights?

Posterior returns move closer to the view-implied returns. Black-Litterman blends prior and views by their precision, so lowering the view's error variance raises its weight and increases the portfolio's tilt away from market-cap weights toward the view.

  1. APosterior returns move closer to the equilibrium returns
  2. BPosterior returns move closer to the returns implied by the view, increasing the tilt toward the viewCorrect
  3. CPosterior returns are unaffected because only the scalar tau controls the blend
  4. DPosterior covariance becomes singular

Explanation

The posterior is a precision-weighted average of the prior and the view. Lower Omega means higher view precision, so more weight goes to the view and the portfolio tilts further from market weights. Option A describes lower confidence.

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