shuford

Nobel Laureates in Economics:The Implications of Their Work for Actuarial Analysis : 

Nobel Laureates in Economics: The Implications of Their Work for Actuarial Analysis Harry Shuford, Chief Economist National Council on Compensation Insurance CASE Annual Meeting September 23, 2004 Atlanta, Georgia

Today’s Discussion: 

Today’s Discussion Background on the Nobel in Economics Areas with Implications for Actuarial Analysis Financial Economics Asymmetrical Information Behavioral Economics/Finance Econometrics Valuable Insights/Observations – part 1 Valuable Insights/Observations – part 2

Today’s Discussion: 

Today’s Discussion Background on the Nobel in Economics

Slide4: 

Financial Economics Markowitz - 1990 for work in the late 1950s Modigliani & Miller – 1990 for work in the 1960s Sharpe- 1990 for work in the 1960s Scholes and Merton – 1997 for work in the 1970s

Slide5: 

Asymmetrical Information Mirrlees – 1996 for work in 1970s Akerlof – 2001 for work in mid to late 1960s Spence – 2001 for work in early 1970s Stiglitz – 2001 for work in mid 1970s

Slide6: 

Behavioral Economics/Finance Kahneman – 2002 for work in the 1970s

Slide7: 

Econometrics Trygve Haavelmo – 1989 for work in the 1940s Engle – 2003 Granger – 2003

Slide8: 

Financial Economics Markowitz - microfinance portfolio theory Mean variance Efficient frontier recognizing covariance of securities Quadratic objective function Modigliani & Miller – corporate finance Capital structure per se (I.e. debt/equity) no effect on value of the firm Expected return on stock increases linearly with debt/equity ratio Stockholders can offset in the market any undesired change in firm’s structure Sharpe – market focus - CAPM Systematic vs. Diversifiable risk Risk premium based on covariance with market return Market portfolio and lending/borrowing @ risk free rate Scholes and Merton – option pricing model Risk is embedded in price of underlying asset Contingent claim concept applies to insurance Strike price - /expected share value +/volatility of share price +/time+/risk free rate +

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Asymmetrical Information Mirrlees – optimal income taxes Moral hazard Disincentive to work to avoid taxes Hide income to avoid taxes Akerlof – sellers have more/withhold info re: buyers - market for lemons Adverse selection Why would I want to buy if he wants to sell? Medical insurance pricing – esp. elderly Spence – better informed incur costs to improve outcomes Signaling Factory mutuals and fire protection services Auto warranties - Stiglitz – poorly informed extract info from better informed Screening Insurance deductibles MGAs and retentions

Slide10: 

Behavioral Economics/Finance Kahneman – decision making under uncertainty/irrational behavior Expected utility is not entirely convex Different response to the same problem depending on how it’s presented Loss aversion Prospect theory Ignore/overlook prior information

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Econometrics Trygve Haavelmo – made econometrics probabilistic Statistical inference/hypothesis testing Simultaneous interactions/identification problem Engle – changing volatility over time autoregressive conditional heteroskedasticity (ARCH) Granger – time series with common trends cointegration

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Valuable Insights/Observations Friedman – policy lags/positive vs normative Lucas – rational expectations Arrow – theory of insurance Simon – satisficing vs. maximizing Tobin – Tobin’s Q/risk free asset vs market portfolio Heckman – selection bias Fogel & North – technology and development Samuelson

Slide13: 

Valuable Insights/Observations The standard model: Self interested rational behavior Full information Akerlof’s “Market for Lemons” story Article rejected twice as being trivial Article rejected as undermining standard model Article finally accepted Today’s models are varied and include: The standard model Models to explain behavior with incomplete and asymmetrical info Behavioral finance – irrational exuberance Auctions (Vickery & Smith) Measuring “happiness” How effective are today’s actuarial methods? Are they seasoned or just stale?

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Thanks for Your Interest Questions and Comments