a stochastic model for return on invested assets
A STOCHASTIC MODEL FOR RETURN ON INVESTED ASSETS
By Martin Stonehouse
1. AIM AND PROBLEMS
1.1 Since economic and business conditions vary over time, business leaders must find ways to keep abreast of the effects that such changes will have on their operations. One technique that a business might adopt as an aid in planning for the level of operational needs is the use of forecasting models. Although numerous forecasting models have been devised, they all have one common goal, to make predictions of future events so that these projections can be incorporated into the decision-making process (Berenson & Levine, 1996). By using forecasting models the decision-maker is provided with a distribution for the variable of interest as well as the range of possible returns on investments.
1.2 The aim of this paper is to present a model projecting the overall returns achieved on invested assets. A statistical model will be derived by making use of the necessary techniques discussed in the various available literature and possibly through the development of new techniques.
1.3 We must keep in mind that it is necessary to strike a balance between the ambition to make the model as realistic as possible and a need to keep the model simple (Hibbert, Mowbray & Turnbull, 2001). The model is intended to be a simplified version of reality that captures the essential features of the problem and aids in understanding. This balance will depend upon a number of considerations such as the specific application of the model as well as the needs and sophistication of model users.
1.4 Models are not the simple solution to all actuarial problems. They have drawbacks that must be understood when interpreting the output from a model and communicating the results to clients. These drawbacks include:
(1) In a stochastic model, for any given set of inputs each run gives only estimates of a model's outputs. So to...
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