Jan 28, 2013

U.S. Inflation 1666-2012

As promised, a nice Mathematica overview of U.S Inflation history.

View and play around with these inflation data to 'grasp' inflation long and short term behavior...

Download the Mathematica CDF player if you haven't already, it's well worth it....

If you can't load the application on this blog, or the panel range becomes wider than the width of the blog column, go here: Stand alone U.S. Inflation website




Jan 20, 2013

SMPLFCTN

As an actuary, you probably grew up with that famous quote of Einstein:

Everything Should Be Made as Simple as Possible,
But Not Simpler.

However, as 'Quote Investigator' shows, there is no direct evidence that Einstein crafted this aphorism...

Hmmmm.... Never mind.... as this quote is clearly redundant and therefore can be simplified....

So, it's enough to stick to the subjective concept of 'keep it simple'.....

'Simple', simply means 'easy to understand'.  

If we would try to present or explain something 'too simple', we are in fact making it harder to understand and therefore 'more complicated'.

Example
If we try to explain that we can estimate the area of a circle (approx. 3.14159...; radius=1) in practice by a n-sided polygon, a three year old child ;-) will buy your simplification in case of  a 12-sided polygon.




Oversimplified, or Worse: Desimplified
In case of a square (4-sided polygon), he'll probably raise his eyebrow, as you oversimplified the topic. And in case of a triangle you'll probably have lost him completely. You desimplified and thereby complicated your case to the opposite of what you untended : a clear understanding.



Simplification Criterion
Keep in mind that, like in the case above, you must develop a criterion when you simplify things. In the above example, a criterion could (e,g) be that the area of the polygon shouldn't differ more than 10% of the original circle and must have a relative simple (round) answer. This criterion would lead to a 12-sided polygon as an adequate simplification example.


And of course, we have to test this ex-ante 12-sided criterion in practice by means of a questionnaire.


Simplification is Complicated
However, 'simplification' as process, is not simple at all. In practice simplification can be used to reduce things that are:
  1. complicated (not simple, but knowable) or 
  2. complex (not simple and never fully knowable) 
In an article called 'Simplicity: A New Model',  Jurgen Appelo tries to simplify the complex world of simplicity linked concepts. He states that simplification means 'make understandable', which means moving it vertically, from the top of the model to the bottom in the following Appelo-illustration.

Anyhow, there's much to learn about simplicity related topics.....   

Let's finish with an excellent example of a need for simplification : 

Simplifying 'Complexity of financial regulation'
In an excellent presentation, Executive Director Financial Stability of the Bank of England,  Andrew Haldane, pleas and argues to simplify financial regulation.

It turns out that the growing number of regulation rules and principles (e.g. Basel III) has an adverse effect on taming the crisis.

Also 
the traditional Merton-Markowitz approach that assumes a known probability distribution for future market risk and enables portfolio risk to be calculated and thereby priced and hedged, offers no help to solve the current crisis.
Haldane concludes that "More simple regulation  based on 'Optimal choice under uncertainty' is necessarily. Haldane concludes:

"Modern finance is complex, perhaps too complex.  Regulation of modern finance is complex, almost certainly too complex.  That configuration spells trouble.

As you do not fight fire with fire, you do not fight complexity with complexity.  Because complexity generates uncertainty, not risk, it requires a regulatory response grounded in simplicity, not complexity. 


Delivering that would require an about-turn from the regulatory community from the path followed for the better part of the past 50 years.  If a once-in-a-lifetime crisis is not able to deliver that change, it is not clear what will.  


To ask today’s regulators to save us from tomorrow’s crisis using yesterday’s toolbox is to ask a border collie to catch a frisbee by first applying Newton’s Law of Gravity.
"


Haldane's (2012) presentation called 'Ensuring Long-Term Financial Stability', or more popular 'The dog and the frisbee', is a breakthrough in managing, modeling and controlling Risk and financial future results. It's a MUST read for actuaries and board members in the financial industry.

Finally
From now in, actuaries can simply start 'helping' as a border collie!

Sources/Links
- BOE Presentatie Andrew Haldan
- Risk models must be torn up
- Mathematica: Play with Polygons
- Einstein's Simple Quote Investigated
- Complex versus Complicated
Complicated vs complex vs chaotic
- Simplicity a new model

Jan 18, 2013

From Economic Scenarios to Informed Guesses

Defining a long term investment strategy build on one chosen economic scenario is reckless.

As crystal ball gazing is no option, defining strategies on more (multi based) economic scenarios makes more sense, but often ignores the underlying forces that drive those economic developments.

And precisely these elemental forces are the drivers for a dynamic investment strategy.

Informed Guesses

What remains as next best solution, is to define an investment strategy on basis of what is called 'Informed Guesses'.

This implies that a strategy is not just build on professional guessing (statistical & actuarial modeling; Monte Carlo, etc). The key to success in the approach is this word 'Informed'...


As board members of financial institutions can not delegate or outsource their investment strategy, they have no other option than to inform themselves about the economic, social,  psychological, financial and statistical underlying forces and to formulate a dynamic investment strategy based on those basic forces.
 
Global Trends 2030
An excellent example of mapping these future driving forces is a December 2012 report published by the U.S. National Intelligence Council (NIC) called 'Global Trends 2030: Alternative Worlds'.

The NIC report does not seek to predict the future, which would be an impossible mission. Instead, it provides a framework that stimulates thinking about our world's rapid and vast geopolitical changes. Resulting in possible global future directions and implications during the next 15-20 years. 

The report defines 4 mega trends and 4 potential worlds:

Mega Trends 
  1. Individual Empowerment and the growth of a global middle class 
  2. Diffusion of Power from states to informal networks and coalitions
  3. Demographic changes, growing urbanization, migration, and aging
  4. Increased demand for food, water, and energy. 

Potential Worlds
  1. Stalled Engines
    Most plausible worst-case scenario: Increasing risks of interstate conflict. The Us draws inward and globalization stalls. 
  2. Fusion Most plausible best-case outcome. Collaboration of China and the Us, leading to broader global cooperation.
  3. Gini-Out-of-theBottle
    Inequalities explode as some countries become big winners and others fail. Inequalities within countries increase social tensions. Without completely disengaging, the Us is no longer the “global policeman.” 
  4. Nonstate World World driven by new technologies, nonstate actors take the lead in confronting global challenges
 
Let's take a look at some interesting charts from this report:

I. Asia's dominant growing consumer power...
 

II. U.S.-Asia's  combined World Power...


III. Europe, GDP Dominant in 2030 ?


IV. U.S.GDP, Any way : Going down...

Conclusion
"Global Trends 2030"is an interesting and relevant document for investment planning, that I would recommend to read, to draw your own conclusions.

A more general conclusion - as stated by NIC - could be that we are heading for a transformed world, in which “no country – whether the US, China, or any other large country – will be a hegemonic power.”

No matter what trend or potential world, one thing seems inevitable:
the influential power of the U.S. that's vital for our world's economy will decline.....


Success with defining new investment strategies!

Bye the way.... Actuaries help you out on your investment strategy:






Sources/Links:
- Escher Image from Freakingnews
- Escher: Hand with Reflecting Sphere (1935)
- Zero hedge: The world in 2030
- World in 2030 (original report (2012)