Framework for Developing Capital Market Expectations

Cross-sectional consistency refers to consistency across asset classes regarding portfolio risk and return characteristics.

Intertemporal consistency refers to consistency over various investment horizons regarding portfolio decisions over time

The following is a framework for a disciplined approach to setting CME.

  1. Specify the set of expectations needed, including the time horizon(s) to which they apply. 
  2. Research the historical record.
  3. Specify the method(s) and/or model(s) to be used and their information requirements. 
  4. Determine the best sources for information needs.
  5. Interpret the current investment environment using the selected data and methods, applying experience and judgment.
  6. Provide the set of expectations needed, documenting conclusions. 
  7. Monitor actual outcomes and compare them with expectations, providing feedback to improve the expectations-setting process.

Steps 2 and 3 in the process involve understanding the historical performance of the asset classes and researching their return drivers.

  • Geography: global, regional, domestic versus non-domestic, economic blocs (e.g., the European Union), individual countries;
  • Major asset classes: equity, fixed-income, real assets;
  • Sub-asset classes:
    • Equities: styles, sizes, sectors, industries;
    • Fixed income: maturities, credit quality, securitization, fixed versus floating, nominal or inflation-protected;
    • Real assets: real estate, commodities, timber.

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