What is the starting point of the Black-Litterman model?

In the Black-Litterman model, the starting point is indeed excess returns from reverse optimization. This model aims to improve upon traditional mean-variance optimization by incorporating investor views and providing a more intuitive framework for portfolio construction.

Specifically, the Black-Litterman approach utilizes the equilibrium market-implied returns, which are derived from a reverse optimization process. This reverse optimization considers the observed market weights of assets and their associated risks, calculating the implied excess returns that would make the market portfolio optimal based on the investors' risk aversion.

By starting with these excess returns, the model then allows the investor to express their unique views on the expected returns of specific assets or asset classes, adjusting the implied returns to reflect these views while still maintaining the benefits of the market equilibrium framework. This method helps avoid the extreme weights and instability often produced by traditional mean-variance optimization techniques based solely on historical returns.

In contrast, net cash flow predictions, historical return averages, and market volatility measures each provide different insights and inputs into portfolio management but do not serve as the foundational element from which the Black-Litterman model builds its optimization framework.