Market Assumptions which are provided by Morningstar may be viewed, but not edited in this dialog box. To modify the market assumptions, you must create a new set of market assumptions based on one of the predefined sets of Morningstar assumptions.
On the Expected Returns tab, do the following:
Click in the Name field to enter a new name for the assumptions if desired.
For each asset class, enter values for Expected Return, Standard Deviation, Yield, and Total Turnover.
To add an asset class, click Add. A line is added. Click the magnifying glass icon on the new line. The Select Asset Class dialog appears.
To delete an asset class, check the box to the left of the asset class name and click Delete. You can only delete asset classes you have added.
Click in the Asset Name field for any asset class you added to edit its name.
Click the magnifying glass icon next to any asset class you added to select a different asset class or edit the current asset class.
On the Correlations tab, do the following:
Click in any cell to edit a correlation value.
Correlations Test
When you modify the correlation matrix by either changing correlation values or adding a new asset class, a suitability test will be performed on the correlation matrix before the assumptions are saved. A correlation matrix must be “positive semi-definite” in order to be used in mean-variance optimization and in forecasting (Monte Carlo simulation). If there is a problem with the correlation matrix, a warning message will appear, warning you that the correlation matrixes were not found to be suitable. You will then have the option to modify the correlations.
If you wish to undo the changes you’ve made, click Yes to modify the correlations, then click Cancel to close this dialog without saving the modified assumptions.
When you add a new asset class to the market assumptions, the software will attempt to calculate default correlations based on the past monthly returns of the associated planning benchmark, and the past monthly returns of the other asset classes’ benchmarks. Each correlation calculation will use all monthly returns over the common time period for which both indexes have returns, going back as far as possible, but limited from 1972 to the present. (If the new asset class does not have a planning benchmark, or has a benchmark with less than three years of monthly returns, correlations will default to zero.) After calculating the historical correlations for the new asset class, the software will automatically perform the suitability test on the resulting correlation matrix.
If the matrix fails the test, the software will then automatically recalculate the entire correlation matrix based on historical monthly returns for the common time period over which all asset class benchmarks have monthly returns, and run the test again. If the test now passes, a warning message will be displayed notifying you that the correlations have been recalculated, and advising you to review the new correlations. If the test still fails, the original correlation matrix will be restored, and the correlations for the new asset class will default to zero.
Problems with the correlation matrix are generally caused by including two overlapping or highly-correlated asset classes. You are strongly advised to avoid such problems by ensuring your asset classes are independent and non-overlapping.