Forecasting Method for Optimal Diversification

Abstract

Forecasting is a technique that uses historical data as inputs to make estimates that are predictive in determining the direction of future trends. The goal of investors is to make optimal choice that leads to minimization of risk and maximization of returns, but the method that leads to these objectives has been a challenge for investor. In this study, Black-Litterman model (BLM) is adopted and two forecasting methods; EGARCH and GARCH methods are used for two parameters of BLM; investor views and level of uncertainty. The aim of this paper is to investigate the best forecasting method to estimate BLM that would lead to minimum risk and maximum returns. The analysis of this paper shows that EGARCH method gives maximum expected returns and minimum risk.