An application of Black-Litterman model in korean equity market

Abstract

This study examines investment value of analyst recommendation consensus on KOSPI50 constituents, and applies this information to Black-Litterman model to examine if abnormal returns can be obtained. For the period from 1 April 2003 to 31 March 2013, we find that portfolio of stocks with high ratings (mostly recommendation of “strong buy” or “buy”) on average earn a higher return than market return, whereas portfolio of stocks with low ratings (mostly recommendation of “hold” or “sell”) earn a lower return than market return. Black-Litterman asset allocation model using this analyst recommendation consensus data enabled investors to obtain significant abnormal returns with better performance than market in terms of risk adjusted performance measures. However, after accounting for transaction cost, significance of abnormal returns was lost. Less frequent rebalancing helped to reduce transaction cost it also lowered raw return and other performance measures due to not being able to capture the rating changes in timely manner. Applying views based on short-term historic recommendation data had a negative effect on raw return, and applying views of portfolios against other portfolios instead of against market increased raw return, but also caused a large turnover.