This discussion pertains to the Asset Classes topic of all ProVal Capital Market Simulation types except a Custom simulation. See Custom Simulation Type for information about the asset classes in a custom simulator.

The initial Asset Classes dialog box lists all the previously Defined Asset Classes, or types of investments, if any, in the current Capital Market Simulation. To edit the parameters for a specific asset class, click its name and complete the parameters in the next (Asset Class) dialog box. Similarly, to define a new asset class, click the Add Class button. You may define an unlimited number of asset classes. To omit an already defined asset class from your capital market simulation, click its name and then click the Erase button in its Asset Class dialog box. Note, however, that, even if the current project is not the universe (i.e., the entire mode), when you click the Erase button, the asset class is deleted. Should you wish subsequently to run a capital market simulation including this asset class, you must input its parameters again. For a description of the parameters of the Asset Class dialog box, see Asset Class Parameters. You may also wish to refer to the discussion of calibrating simulators (multi-factor term structure type) for assistance in setting the parameter values for the Multi-Factor Term Structure and Explicit Corporate Yield Curve simulators.

You may change the order in which the defined asset classes appear on this screen, in the correlation matrix and in output: just click the Re-order button and Modify the Order column to rearrange asset classes in the next (Reorder Asset Classes) dialog box. If you have a correlation matrix that you wish to cut/paste into ProVal, reordering the asset classes to match the order of your Excel spreadsheet will make the job easiest.

Once the asset classes are defined, click the Correlations button to enter a matrix of correlation factors. This leads you to the Asset Class Correlation Matrix dialog box, where each asset class (other than those created as a zero coupon bond asset class) appears, in the previously selected order, in a two-dimensional matrix, along with unexpected inflation (Unex.Inf.) for the Classic Mean/Variance simulator. If you have checked the box to Simulate Benchmark Yield for 30-Year governments, under the Benchmark Yields topic of a mean/variance simulator, then the yield on 30 year government bonds (YldGov30), or their substitute, also appears. If you have also checked the box to Simulate Benchmark Yield for Corporate Bonds, under the Benchmark Yields topic of a mean/variance simulator, then the yield on corporate bonds (YldCorp) also appears. As each item is correlated perfectly with itself, ProVal has entered 1 along the diagonal. For other values in the matrix, you need to Enter the correlation coefficients, which indicate the correlations of returns among asset classes and, for the mean/variance simulator, with unexpected inflation and with government and corporate bond yields if simulated. (Note: correlation factors for unexpected inflation would typically be negative or zero.)

Because ProVal’s simulators use different methods to develop nominal rates of return, the mean/variance simulator correlates real return rates, while the multi-factor term structure and explicit corporate bond simulators correlate the residuals, based on a regression equation, of total rates of return. Typically, the correlations of the regression residuals are similar to the expected correlations of nominal returns. Inflation is not included in the correlation matrix of a multi-factor or explicit corporate bond simulator; instead, total inflation is correlated with the real return rate of 1 year government bonds; see Real Rate & Term Premium for the applicable parameter. Nor is the 30 year government yield included for the multi-factor or explicit corporate bond simulator, as return rates for the interest rate-dependent investments (government and corporate bonds) are not modeled by means of a regression equation.

When you click OK, to return to the Asset Classes dialog box, ProVal determines whether the matrix is valid for use in generating the desired variables. If it is not, you will get a message that the matrix “cannot be factored” and will have options to save the correlations as input, lose your changes, or to click Adjust and have ProVal suggest a matrix that will factor. If you choose this last option, ProVal will calculate the valid correlation matrix that is nearest to the matrix you input and display it in a new dialog box along with the matrix you had input. You must then decide whether this adjusted matrix is acceptable for your work. Click OK to accept the adjusted matrix and overwrite your inputs or click Cancel to continue editing your matrix by hand. The Capital Market Simulation will not run until a valid correlation matrix is entered. For more information, see the Technical Reference article entitled Correlation Matrix Validity.

When you have finished entering asset classes, click the OK button to return to the Capital Market Simulation dialog box.