Enhanced Scenario Analysis

23 Pages Posted: 20 May 2019 Last revised: 15 Jun 2019

See all articles by Megan Czasonis

Megan Czasonis

State Street Corporate

Mark Kritzman

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Baykan Pamir

State Street Associates

David Turkington

State Street Associates

Date Written: May 3, 2019

Abstract

Investors have long relied on scenario analysis as an alternative to mean-variance analysis to help them construct portfolios. Even though mean-variance analysis accounts for all potential scenarios, many investors find it difficult to implement because it requires them to specify statistical features of asset classes which are often unintuitive and difficult to estimate. Scenario analysis, by contrast, requires only that investors specify a small set of potential outcomes as projections of economic variables and assign probabilities to their occurrence. It is, therefore, more intuitive than mean-variance analysis, but it is highly subjective. The authors propose to replace the subjective elements of scenario analysis with a robust statistical process.

Keywords: Covariance matrix, Economic scenarios, Euclidean distance, Financial turbulence, Gradient descent, Mahalanobis distance, Mean reversion, Mean-variance analysis, Multivariate normal distribution, Persistence, Scale independent, Scenario analysis

JEL Classification: C01, C02, C13, C18, C4, C6, G10, G17

Suggested Citation

Czasonis, Megan and Kritzman, Mark and Pamir, Baykan and Turkington, David, Enhanced Scenario Analysis (May 3, 2019). MIT Sloan Research Paper No. 5774-19. Available at SSRN: https://ssrn.com/abstract=3389977 or http://dx.doi.org/10.2139/ssrn.3389977

Megan Czasonis

State Street Corporate ( email )

1 Lincoln Street
Boston, MA 02111
United States

Mark Kritzman (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

Baykan Pamir

State Street Associates ( email )

140 Mt. Auburn St.
Cambridge, MA 02138
United States

David Turkington

State Street Associates ( email )

United States

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