Great Question! Every Monte Carlo simulation planning tool has to be provided assumptions about how financial markets behave. These assumptions are known as Capital Market Assumptions (CMAs). They define for each asset class its expected return, riskiness (also known as volatility), and how much the asset class moves in tandem with other asset classes (correlation).  

By far the most commonly used CMA modeling technique is “Static” CMA modeling. As the name suggests, Static CMAs do not change very much. They are typically calculated from long term average statistics and only change as often as those long term averages change.

Caravel’s founder Michael Jones constructed an alternative CMA model more than 15 years ago. We refer to this alternative CMA model as “Price Driven” CMAs. Under Price Driven assumptions, expected returns for the various asset classes are assumed to go up and down with the asset class valuation (it’s “price”). For example, when interest rates are far below average as was the case for much of the past 10 years, expected returns calculated from Price Driven CMA models indicate that cash and bond returns are likely to be below average. Now that Fed policy has pushed rates back to more normal levels (and bond prices have fallen sharply), Price Driven CMA model expect more average returns from bond investments.

CMPAS advisors can select whether they prefer Static or Price Driven CMAs to determine results for their client plans and asset allocation strategies. Alternatively, advisors who have licensed or developed their own CMA methodologies may upload their proprietary calculations.