CONTENTS
1 INTRODUCTION.................................................................................................................9
1.1 AIM AND PURPOSE.........................................................................................................10
1.2 METHODOLOGICAL CONSIDERATIONS ......................................................................10
1.3 OUTLINE........................................................................................................................16

2 THE MARKOWITZ MODEL ...........................................................................................17
2.1 THE MODEL...................................................................................................................18
2.2 PROBLEMS IN THE USE OF MARKOWITZ’ MODEL .....................................................19
2.3 HISTORICAL DATA ........................................................................................................22
3 THE BLACK-LITTERMAN MODEL .............................................................................23
3.1 THE FRAMEWORK AND THE IDEA................................................................................24
3.1.1 Equilibrium ...................................................................................................................25
3.1.2 Investor Views and Levels of Confidence.............................................................................27
3.1.3 Combining Views with the Equilibrium Expected Returns ....................................................27
3.2 THE BAYESIAN APPROACH TO THE B-L MODEL........................................................29
3.3 SAMPLING THEORY APPROACH AND THE BLACK-LITTERMAN MODEL..................31
3.3.1 Sampling Theory ............................................................................................................32
3.3.2 The Sampling Theory Approach to the Black-Litterman Model .............................................33
3.4 RESULTS .........................................................................................................................41
4 BEHAVIORAL FINANCE AND THE BLACK-LITTERMAN MODEL –
IMPLICATIONS..................................................................................................................45
4.1 BEHAVIORAL FINANCE..................................................................................................46
4.1.1 The History of Behavioral Finance....................................................................................46
4.1.2 The Different Parts of Behavioral Finance..........................................................................47
4.2 BEHAVIORAL FINANCE AND QUANTITATIVE FINANCIAL MODELS ..........................48
4.2.1 Research Concerning Portfolio Models ...............................................................................49
4.3 BEHAVIORAL FINANCE AND THE BLACK-LITTERMAN MODEL.................................50
4.4 THE B-L MODEL AND THE UTILITY FUNCTION .........................................................50
4.4.1 Regret...........................................................................................................................53
4.4.2 The Status Quo Bias and the Endowment Effect.................................................................54
4.4.3 Herd Behavior................................................................................................................56
4.4.4 Implications for the B-L Model ........................................................................................56
4.5 THE B-L MODEL AND OVERCONFIDENCE...................................................................58
4.5.1 What is Overconfidence? ..................................................................................................58
4.5.2 When are Investors Overconfident? ....................................................................................60
4.5.3 What Does Overconfidence Lead To? ................................................................................62
4.5.4 Implications of Overconfidence and the Levels of Confidence ..................................................63
4.5.5 Confidence Levels and the Home Bias................................................................................65
4.6 BEHAVIORAL FINANCE AND THE B-L MODEL – WHAT IT GAVE AND DIDN’T GIVE?
........................................................................................................................................66
5 FURTHER RESEARCH.....................................................................................................71
5.1 OTHER TYPES OF FINANCE...........................................................................................71
5.1.1 Social Studies of Finance .................................................................................................72
5.1.2 Organizational Finance ...................................................................................................73
5.1.3 Post-Modern and Post-Autistic Finance.............................................................................74
5.2 ORGANIZATIONAL STRUCTURE AND THE USE OF THE B-L MODEL ........................76
5.2.1 Who should Set the Weight-On-Views ..............................................................................76
5.2.2 Decision Groups .............................................................................................................77
5.3 FURTHER RESEARCH ....................................................................................................78
LITERATURE:.............................................................................................................................81
APPENDIX 1.................................................................................................................................89
Background.................................................................................................................................89
APPENDIX 2.................................................................................................................................93
Markowitz’ Mean-Variance Model ................................................................................................93
APPENDIX 3.................................................................................................................................99
Assumptions ...............................................................................................................................99
APPENDIX 4...............................................................................................................................101
Behavioral Finance .....................................................................................................................101