Abstract
Inflation risk poses a significant challenge to strategic asset allocators and is forcing many to reevaluate the suite of quantitative tools they use. In particular, standard simulation methods are inadequate for modeling inflation dynamics and do not generate uncertainty in long-term average inflation. Furthermore, despite low-frequency regime switching between negative and positive stock–bond correlation regimes, linked to inflation dynamics, standard methods do not incorporate this either. Finally, when markets are undergoing long-term structural changes, modeling choices should be able to integrate the forward-looking expectations of subject matter experts on joint economic and market dynamics. This article describes a simple way of retrofitting these features to an existing simulation engine.
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