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Niels K. Pedersen, Helen Guo
Scenario analysisThis model accommodates any combination of GDP and inflation views. Hence, as mentioned earlier, instead of providing results for broad categories like “low-stable-high” growth, the model directly translates point estimates of GDP growth and inflation into risk factor returns.For scenario analysis, the model multiplies sensitivities (betas) by expected surprises, which are defined as the differences between the GDP and inflation scenario and current consensus expectations (summarized by the survey of professional forecasters). In this context, only if the investor’s macro view differs from current expectations will the estimated returns be affected. If the scenario is identical to current market expectations, the realized surprise will be zero, and estimated excess returns will be measured as follows:
As an illustration of macro scenario analysis, Figures 4, 5 and 6 show heat maps of scenario returns for equities, bonds and a simple 60/40 portfolio. Figure 4 shows equities are extremely sensitive to growth surprises. For bonds, three effects compete:
Hence Figure 5 shows under all scenarios which of these effects dominate in this specific example.Lastly, because the 60/40 portfolio is dominated by equity risk, Figure 6 shows that its overall sensitivity to macro shocks is similar to equities. The magnitudes are muted, however, by a diversification effect with interest risk (duration).
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