Solve for the short answer question: (a) True or False: The Black-Litterman mode

Question

Solve for the short answer question:

(a) True or False: The Black-Litterman model suffers of a major drawback: it is too sensitive to analyst's alpha forecasts, because of this issue it usually recommends extreme asset allocation positions. (b) True or False: The Treynor-Black model model allows portfolio managers to quantify complex forecasts (what they call views) and apply these views to portfolio construction c) Explain: Imagine you and your best friend are walking in uptown Minneapolis on a fine spring afternoon. A mild breeze flows gently and a $50 dollars bill rolls over the side walk in front of both of you. Your friend, who took Financial economics before, says: "Don't bother picking up that bill, believe me, it must be fake. The strong version of EMH stays that on a street full of people is impossible to find such arbitrage opportunities, if it were really a 50 bill it would have been picked up by now" State each version of Efficient Market Hypothesis (EMH) and using this knowledge argue in favor or against your friend's reasoning, and explain what you would do. Is it possible that your friend is right?

Explanation / Answer

a) True. Black litterman model is too sensetive to analyst alpha forecast. It is so because black litterman model assumes that there is some private information will be avaliable with the analyst. And this will affect the weight allocation to different stocks. So this can lead to extreme asset allocation position were major weights will be aloted to fw stocks only.

b) true. The teynor black model allows the manager to forecast the alpha and use it in portfolio construction. the alpha is generated for the factor model and used to create active portfolio.

c) EMH is the effecient market hypothesis which says that it is immposible to "beat the market" because all the information is factored into the market every one knows about it. This is what my friend was telling when I went to take up the note. He thinks by the time the note reached me, people must have got the news the $50 is rolling over the side walk. He believes that if this was a real note soemone would have picked up as stated by EMH. But I can counter him by letting him know that thre are three types of EMH. that are weak form, semi strong form and strong form of EMH.

So, what if it is a weal form of EMH, then maybe not every news (privalt or public) will be factored in. Maybe only he got to know that the $50 note was rollling over the side walk. So , on this assumption that it is a Weak Form EMH we can say that it is a real note as not many people know about it. But my friend on the assuption of Strong EMH can conclude that everyone knows about it have people would already have seen the dollar note so it will be fake only.

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