Choosing a Reference Model
Now that the main reference models have been described we can provide some guidance on
using one model or the other. The most common reference model in the literature is the
Canonical Reference Model. Meucci and a few other authors work with the Alternative
Reference Model. The Hybrid Reference Model is used less frequently since the Alternative
Reference Model has been developed.
The primary reason to use the Canonical Reference Model would be to pick up the additional
information from the model via the updated posterior covariance matrix. This additional
information from the model comes at the cost of needing to determine the additional factor τ.
Investors willing to accept the simpler Alternative Reference Model can avoid the need to
consider τ.