The Appropriateness Of A Mean Variance Simulation Model...

The appropriateness of a Mean-Variance Simulation Model for a Commonwealth public sector defined pension benefit fund Kevin Lian October 20, 2014 In this section, we will examine the use of a mean-variance simulation model on a commonwealth public section defined pension benefit fund. Firstly, we will examine the expected medium term returns using the reverse optimisation approach and discuss whether any adjustments are necessary. Secondly, we will examine how appropriate the model is for the fund. Lastly, we will discuss how to determine any inconsistencies if a mean-variance model is used. Expectations for medium term returns The market portfolio consisted of 8 asset classes 1 , in which we used an adjusted allocation size based on APRA†¦show more content†¦This is emphasised by the near singular correlation matrices 2 . Furthermore, the results are extremely sensitive to these mean and variance assumptions due to the structure of the M-V model. This exposes our results to a potentially unbounded error size. Thus, we suggest a Bayesian adjustment is needed to reflect our uncertainty about our assumptions. 1 AE - Australian Equity, IE - International Equity, LP - Listed property, UP - Unlisted Property, AFI - Australian Fixed Interest, IFI - International fixed Interest (Hedged), Cash - $AUD 2 This can be seen by determinants of the 5, 6, and 7 year correlation matrices, which were 2.31258E-48, -9.99469E- 34, and -1.72439E-20 respectively 1 Group B Part D ACTL4303 Assignment Student ID: 3374652 Furthermore, the results in Table 1 also requires some adjustments due to tax and the inherent assumptions of the reverse optimisation approach. In general, the returns of each asset class need to be subjected to the appropriate tax deductions and transaction fees. In particular, Australian equity returns have not accounted for the franking credits. In addition, the method used to calculate the risk-aversion coefficient result in time-invariant equity returns. Thus, adjustments are needed to reflect time-vary equity risk premiums. In