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I am trying to work out the formula for the posterior mean in Black Litterman's model assuming 100% confidence : mean_posterior

Ref: https://corporate.morningstar.com/ib/documents/MethodologyDocuments/IBBAssociates/BlackLitterman.pdf

(Equation 9).

My problem is that the covariance matrix Sigma of the daily returns i'm using is very small such that when I take the inverse of the required expression the values are exploding...can anyone suggest what to do in such a case?

Thanks!

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  • $\begingroup$ Yes, the daily returns covariance matrix will be small, but that should not necessarily be a problem if all of your inputs are on the same scale ($\Omega$, $\Pi$). It's probably easier to convert everything to an annual scale. $\endgroup$ – Tim Wilding Aug 27 '18 at 12:14

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