This post deals with the Theil mixed estimator which uses the prior information as well as the sample information.
Theil mixed estimator incorpoate stochastic non-sample information into a linear model. This estimator mixes sample and prior information in a generalized least squares sense. Information regarding GLS estimator can be found at the following previous post.
Linear model with sample information
Sample information is represented by the following linear model.
Linear model with sample and prior information
Prior information has the following form
where R is J × K and r is J × 1. ν is a J × 1 normally distributed random error vector.
Incorporating the prior information into the sample information leads to the following model specification.
The GLS estimator is as follows.
By using matrix multiplications, this result can be simplified to
where ϕ stands for the precision of the regression model : ϕ = 1/σ2.
By inverting and its variance can be obtained.
This is the Theil mixed estimator.
Theil mixed estimator
More generally, when is used instead of the Theil mixed estimator can also be represented
This post derived the Theil mixed estimator which uses the prior information as well as the sample information. This formulation will be used when deriving the Black-Litterman model.
Visit the SH Fintech Modeling Blog to read more about this topic: https://kiandlee.blogspot.com/2022/09/theil-mixed-estimator.html.
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