EXPECTED UTILITY USING BLACK LITTERMAN MODEL

ABSTRACT

The main goal of any investor is to minimize risk at any point of given returns or maximize returns at any given risk. The Markowtz mean-variance (MV) model is widely used in solving investment problem but is tedious and the results are often extreme. The investor who use it encountered difficulties when adding many constraints into the model. There have been many attempts to alleviate the problems of MV model. On this basis, the Black-Litherman (BLM) model was developed to search for the best solution to the problem. The study demonstrates the benefits of diversification of each assets in portfolio. The assets allocations reviewed by BLM is used to estimate both expected return and risk. We explored data of Gold, Silver and Tin from Yahoo finance. In view of this, the BLM was developed to search for the utility which is the overall returns and also to estimate the effects of Tau on variance which is the measure of risk and mean which is the expected return. Tau is calibrated into ten values which is 0.1 to 1.0 with increment of 0.1. The results discovered, demonstrate that as tau increases, the value of risk decrease and the values of returns for stock increase simultaneously.