Are positive exogenous shocks as disruptive to CME as negative ones? How should I adjust my framework for each type?
Most of the CFA examples focus on negative shocks (crises, pandemics). But the curriculum also mentions technology breakthroughs. Do positive shocks cause the same kind of model breakdown, and how should I think about incorporating them into forward-looking CMEs?
Great question — positive and negative exogenous shocks BOTH break forecasting models, but they do so in different ways and on different timescales.
The Asymmetry:
Negative shocks tend to be sudden and dramatic — a financial crisis, a pandemic, a war. Markets reprice within days. The CME failure mode is that models lacked the scenario or assigned it near-zero probability.
Positive shocks tend to be gradual and diffuse — the internet revolution, the post-WWII global trade expansion, the green energy transition. Markets reprice slowly over years. The CME failure mode is that models anchored to old trend growth rates long after the structural improvement began.
Example — Meridian Pension Fund's Technology Shock:
Consider how the rise of the commercial internet (1995–2005) affected CME:
Phase 1 — Denial (1995–1997): Most CME frameworks treated the internet as a niche technology. Growth estimates remained anchored to the 1980s trend of ~2.5% real GDP growth. Equity return forecasts didn't incorporate productivity acceleration.
Phase 2 — Euphoria (1998–2000): Once the productivity impact became undeniable, forecasters overshot in the opposite direction. The 'new economy' narrative extrapolated infinite growth with no valuation constraints. CMEs became divorced from economic fundamentals — the very mistake the curriculum warns about.
Phase 3 — Recalibration (2001–2005): After the tech bust, a more measured assessment emerged. Productivity growth had genuinely shifted higher (from ~1.5% to ~2.5% per year), but not by as much as the euphoria suggested. CMEs eventually settled on a modestly higher trend growth assumption.
Practical Framework for Incorporating Shocks:
| Step | Negative Shock | Positive Shock |
|---|---|---|
| 1. Identify | Watch for sudden dislocations, contagion, liquidity events | Watch for persistent productivity gains, declining costs, new market creation |
| 2. Assess permanence | Is this a one-time level shift or a permanent growth rate change? | Is the productivity gain sustainable or a one-off measurement artifact? |
| 3. Adjust CME | Widen confidence intervals, add tail-risk scenarios, reassess correlations | Gradually raise trend growth, test whether valuation multiples should expand |
| 4. Avoid overcorrection | Don't assume every downturn is a permanent impairment | Don't assume every innovation creates a permanent new paradigm |
Key Principle: The biggest CME errors don't come from getting the magnitude of a shock wrong — they come from failing to recognize that a shock has changed the underlying regime. Whether the shock is positive or negative, the critical question is always: 'Has this changed the structural growth rate, or is this a temporary deviation from an unchanged trend?'
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