Abstract for: A System Dynamics Approach to Modeling the Global Capital Markets

The holy grail of investing is to earn an attractive rate of return over time while avoiding the steep losses that typically afflict conventionally managed portfolios. To achieve this goal, it is essential to understand the causal factors and risks that impact the global capital markets in a systematic manner that represents the complexity of the real world. In a departure from conventional industry practice, a theory of global capital market behavior has been created in an attempt to describe the economic, fundamental and behavioral interrelationships that drive markets. To guide investment decision making, this theory has been expressed in a computer-based mathematical model that employs a System Dynamics approach. The purpose of this paper is to share the underlying principles and logic supporting the Model, which is employed as the key quantitative driver of an investment management process to construct globally diversified portfolio strategies on behalf of clients. The Model consists of a system of nonlinear differential equations using a System Dynamics approach that describes the causal interrelationships among key global capital market, economic, fundamental and investor behavioral variables. These equations represent research spanning over three decades seeking to identify the key drivers of market behavior of a set of equity, fixed income, hard asset, real estate and currency indices across the U.S., Europe, Asia and emerging markets.