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Behavioral Finance and its Implication in the use of the Black-Litterman Model

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  • Charlotta Mankert
  • Michael Seiler

Abstract

This article discusses the behavioral implications of the Black-Litterman model. In behavioral finance, the utility function of the investor is reference-based, and investors estimate losses and gains in relation to this benchmark. Implications drawn from past research within the field indicate and explain why the portfolio output given by the Black-Litterman model appears more intuitive to fund managers than portfolios generated by the Markowitz model. Another feature of the Black-Litterman model is that the user assigns levels of confidence associated with each asset view in the form of confidence intervals. People are overconfident in financial decision-making, particularly when stating confidence intervals, which is particularly problematic for this model. Hence implications from research regarding overconfidence do not favor the use of confidence levels when weighting portfolios.

Suggested Citation

  • Charlotta Mankert & Michael Seiler, 2012. "Behavioral Finance and its Implication in the use of the Black-Litterman Model," Journal of Real Estate Portfolio Management, Taylor & Francis Journals, vol. 18(1), pages 99-121, January.
    • Handle: RePEc:taf:repmxx:v:18:y:2012:i:1:p:99-121
    DOI: 10.1080/10835547.2012.12089911
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