tag:blogger.com,1999:blog-582368152716771238.post207672707623021747..comments2024-08-11T04:03:06.585-05:00Comments on The Grumpy Economist: The Value of Public Sector PensionsJohn H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.comBlogger40125tag:blogger.com,1999:blog-582368152716771238.post-24797863383016690122014-01-16T08:36:19.354-06:002014-01-16T08:36:19.354-06:00Prof Cochrane,
understand the median shift reducin...Prof Cochrane,<br />understand the median shift reducing the average expected outcome by 1/2 of variance. Can you please throw some more light on why the mode has to be lower than the median? also, how this curve would move given the practical non-iid and mean reverting tendencies (specially after herd/forced actions during euphoria and despair)? Thank you Ramadoss AXP2 AlumniRamadosshttps://www.blogger.com/profile/17346468028742726407noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-67770859053894008582014-01-16T07:49:47.071-06:002014-01-16T07:49:47.071-06:00Prof Cochrane,
understand the median shift reducin...Prof Cochrane,<br />understand the median shift reducing the actual outcome by 1/2 of variance. Can you please throw some more light on why the mode has to be lower than the median? also, how this curve would move given the practical non-iid and mean reverting tendencies (specially after herd/forced actions during euphoria and despair)? Thank you Ramadoss AXP2 AlumniRamadosshttps://www.blogger.com/profile/17346468028742726407noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-58286001362607614742013-09-20T04:24:24.037-05:002013-09-20T04:24:24.037-05:00When you "divide by zero" you shouldn...When you "divide by zero" you shouldn't be surprised when the results get weird.JB McMunnhttps://www.blogger.com/profile/15468282698533043544noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-17261869513621764652013-08-13T12:37:34.330-05:002013-08-13T12:37:34.330-05:00Reporting shortfall probabilities to asses funding...Reporting shortfall probabilities to asses funding status is a teaching idea that may ultimately backfire. Shortfall probabilities are neither necessary nor sufficient. It's not necessary, since once you know the present value shortfall you already know everything you need to know. It's not sufficient because the probability of the loss independent of the magnitude of the loss and the state of the world in which it occurs is meaningless.<br /><br />Reporting shortfall probabilities and magnitudes is a good idea in<br />assessing the investment policy of the fund. If you have real liabilities growing with inflation plus some fraction of real GDP growth, why would you be invested in nominal bonds instead of say a portfolio of inflation indexed bonds and stocks? But that's a question<br />about asset-liability matching, not about the funding status.<br /><br />obelixhttps://www.blogger.com/profile/13404559782994766876noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-17908054581842274312013-08-07T22:54:04.232-05:002013-08-07T22:54:04.232-05:00Prof Cochrane, applying this insight to private in...Prof Cochrane, applying this insight to private individual pension portfolios, would you say that the notion of investing in stocks over the long run because "time diversification reduces risk" (measured as annualized return) is nonsense because risk measured as probability of shortfall rises exponentially? Does this make sense to you: http://www.norstad.org/finance/risk-and-time.html ?sumeetnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-89085345316471843142013-07-29T11:33:54.185-05:002013-07-29T11:33:54.185-05:00If you went back in time that might be a workable ...If you went back in time that might be a workable solution. The problem is they have been under funding for decades so the accumulated amount is much greater. Plus many of the plans have used bond issues to meet funding requirements, so now you have the double whammy of meeting current pension funding while simultaneously paying on the bonds.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-18624185427152591012013-07-26T21:41:47.120-05:002013-07-26T21:41:47.120-05:00There is a federal program for retirees that has m...There is a federal program for retirees that has more than doubled in the last 10 years to $152.7 billion in outlays (FY2014). This program has benefits that would make French railway workers blush.<br />One needs to be a federal employee only for 20 years to receive full lifetime pension and medical care under this program. Due to the aging population of ex-employees already receiving benefits, outlays will inevitably soar even more in the future.<br />I am speaking of the Department of Veterans Affairs.<br />Unlike Social Security or Medicare, this program is not funded by payroll taxes on the people who will also become beneficiaries one day.<br />The VA is purely redistributive. It takes money from corporate and personal incomes taxes and gives the money to VA beneficiaries. Call socialism GOP-style.<br />VA outlays will easily surge past $200 billion in just a few more years. The value of the just the pension portion of the VA program is placed at $2-3 million per beneficiary. It would be cheaper to give each ex-employee $500k upon retirement. <br />But the VA is a sacred cow. Forget about cutting this monstrosity. Just pay up. <br />Benjamin Colehttps://www.blogger.com/profile/14001038338873263877noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-64320791827353667462013-07-26T12:04:44.921-05:002013-07-26T12:04:44.921-05:00You (AM) are right about the practical problems of...You (AM) are right about the practical problems of adjustable contributions. I use this as a simplifying assumption to try to uncover the core complaint about pensions.<br /><br />It seems to me that the underlying complaint is simply that equities are too risky. Shouldn't use them, except maybe for gambling. This is a reasonable argument, but clearly applies to all retirement savings , not just pensions.<br /><br />Or do pensions somehow multiply a risk that is OK for individual retirement plans? <br /><br /><br /><br /><br /><br />srwnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-53030872186117929482013-07-26T11:47:01.279-05:002013-07-26T11:47:01.279-05:00Adjusting contributions in practice (e.g. in a 401...Adjusting contributions in practice (e.g. in a 401k plan) is going to be very difficult for most salaried employees who are already stretched to make the basic contribution and may not be prepared to handle fluctuations in their cash flow.<br /><br />As a general note, a continuous stream of contributions over 50 years has a relatively short "duration", less than 20 years, which means that the average investment horizon of monies invested is much shorter than the ever elusive "long term".<br />AMhttps://www.blogger.com/profile/05972255665912176572noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-45062154088307780222013-07-26T11:42:17.553-05:002013-07-26T11:42:17.553-05:00Again, I have discussed this topic extensively in ...Again, I have discussed this topic extensively in this paper:<br />http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1904992<br /><br />Personally, I think there has been a critical misunderstanding about the properties of strategic asset allocation, which has lead to overconfidence in the properties of diversification as a risk management tool, at the expense of paying attention to secular changes in asset returns. There is some mean reversion in stocks, but it is not sufficiently strong to prevent large variations of final outcomes even over 20+ year time horizons.<br /><br />The only way to take advantage of the cycles is through a more tactical portfolio construction approach.<br /><br />I'd be interested in opinionsAMhttps://www.blogger.com/profile/05972255665912176572noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-10172404654260360162013-07-26T11:33:13.588-05:002013-07-26T11:33:13.588-05:00"Smithers has found is that the longer the pe..."Smithers has found is that the longer the period of analysis, the lower the variance of geometrically-compounded returns."<br /><br />The reason for this result is an elementary error in statistical analysis. The statistics in this case is applied to the "annualized" returns, not to the returns over a full period (e.g. 20 years). It is an elementary property of random walk that the volatility of the "annualized" returns decreases as the square root of time, while the volatility of the full period returns actually increase as the square root of time.<br /><br />For an investment portfolio, this means that the dollar risk of a shortfall actually increases with time, contrary to common wisdom.<br /><br />This is the old debate about "Time Diversification" originally discussed by Samuelson.AMhttps://www.blogger.com/profile/05972255665912176572noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-54449071835547985382013-07-26T10:17:33.106-05:002013-07-26T10:17:33.106-05:00Prof. Cochrane:
What we're all dying to know ...Prof. Cochrane:<br /><br />What we're all dying to know is, who's your pick? Summers or Yellen?Samhttps://www.blogger.com/profile/03796339415643845682noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-87384213859156842902013-07-25T14:48:13.870-05:002013-07-25T14:48:13.870-05:00Professor Cochrane,
this topic is very dear to my...Professor Cochrane,<br /><br />this topic is very dear to my heart since I have been talking about similar issues for quite some time (see e.g. here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1904992)<br /><br />The one perspective I can offer is that at this stage of the game the problem is largely behavioral, not financial. Acknowledging the problems you highlight can open a can of worms in terms of defaults, lawsuits and more. Furthermore, there are strong commercial interests in NOT exposing this problem which kind of dents the whole Strategic Asset Allocation paradigm. While there may be operators who do not fully appreciate the problems, for many others ignoring the issue is largely a matter of career survival. Sometimes denial is the only remaining strategy, while hoping for some miracle ...<br /><br /><br />AMhttps://www.blogger.com/profile/05972255665912176572noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-63111345639108126332013-07-25T11:09:18.823-05:002013-07-25T11:09:18.823-05:00A note on your math... not the math itself but the...A note on your math... not the math itself but the way the numbers are presented.<br /><br />While the modal probability is indeed less than the risk free rate, the probability that you earn less than the risk free rate is still in fact rather small. The chance that you will earn less than the risk free rate after 50 years is 0.078% Which is not insignificant, and sup-par returns to this degree should still be planned for by every treasurer, city manager, and pension manager.<br /><br />But, the way you present the numbers makes it look like investing is a suckers game, when, in fact, that is not the case.<br />Anonymoushttps://www.blogger.com/profile/06862418730092856369noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-11730964320164034042013-07-25T09:53:01.865-05:002013-07-25T09:53:01.865-05:00wouldn't it be better not to pre-fund public p...wouldn't it be better not to pre-fund public pensions; put them at risk; your city fails, you don't get paidAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-9473526197936377542013-07-24T23:36:14.904-05:002013-07-24T23:36:14.904-05:00The comments about the nature of pensions having t...The comments about the nature of pensions having to make many periodic payments are definitely interesting, but I wonder how to factor in another periodic payment: dividends.<br /><br />A boring US stock index fund like an S&P tracker has historically paid about a 2% dividend on top of any capital gains. This element of the return, while variable, is much less variable than the cap gains element. If we break out the return into 4% cap gains (subject to normal standard deviation) and 2% dividends (which are a function derived from cap gains) annually, how does that impact the analysis?Anonymoushttps://www.blogger.com/profile/10334513664759839550noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-20577073833574850492013-07-24T23:24:16.522-05:002013-07-24T23:24:16.522-05:00The government will sooner bring back slavery so t...The government will sooner bring back slavery so the bureaucrats can be paid in full. I expect the prison population to surge to provide a massive pool of unpaid labor.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-1504190546579640742013-07-24T21:56:25.316-05:002013-07-24T21:56:25.316-05:00The real scary thing is that your hypothetical is ...The real scary thing is that your hypothetical is actually understating the risk for tractability. Normal distributions are fully characterized by their mean and variance while we know that there is in fact substantial kurtosis and skew in returns. Add time varying factors (a la stochastic volatility) and you get results that have convinced me of the futility of equal weighting the discount factor for return scenarios. <br /><br />There are other more fundamental macro-economic issues such as if we are able to tax (in the economic sense) the marginal returns to work enough to fund these schemes. There are limits to the systems ability to transfer surplus and still be viable.... freebee34https://www.blogger.com/profile/07232128976487957443noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-46504660524647211802013-07-24T21:16:55.122-05:002013-07-24T21:16:55.122-05:00True. Clearly an important issue is "who bea...True. Clearly an important issue is "who bears the risk." Let's say the whole contribution comes from the participants. Now, is the risk they bear different in important ways than what they would take on as individual equity investors? <br /><br />In other words, is you basic point that equities are simply too risky for any retirement savings? Or is it that the structure of defined benefit pensions somehow multiplies the inherent risk?srwnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-55191541597232834562013-07-24T21:08:39.896-05:002013-07-24T21:08:39.896-05:00Over what 50 year period have we seen a 6% return ...Over what 50 year period have we seen a 6% return on stocks? Just curious... And in most cases, plans will change the discount rates based on "experience," much like they do for inflation, mortality, etc. Plans have been scaling down their assumptions, to where now 8% is on the high side as of 2013. I understand both sides of the argument, but financial economists are presenting a rather tired argument, especially given that RFR's are at historical lows. Much, much, more interesting and ground-breaking would be the implications if public plans liabilities were discounted along the treasury curve. How then would they invest? What would rising rates mean to funded status? How would funded status volatility (presumably caused now by interest rate volatility) affect local municipalities--now funded status will drop in times of crisis. J.W. Lewishttps://www.blogger.com/profile/12744904955574133917noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-19617120955797870542013-07-24T17:37:56.071-05:002013-07-24T17:37:56.071-05:00I think there is a genuine disagreement as to the ...I think there is a genuine disagreement as to the data. I will try and link to a citation of Smithers or Siegel.<br /><br />Separately, I agree with the larger point, that "reaching for yield" often behaviorally leads to greater risk taking. Also, note that Fed QE policies make these assumed 8% returns much harder to achieve. Both directly (because many pension funds are 60/40 bonds/stocks, so the bond portion of the return is decreased artificially buy Fed buying) and through the "portfolio channel" where the forward return on all risky investments (equities, real estate, etc.) is bid down in response to the QE policy. The Fed makes it harder for pension funds to achieve their stated goals; in real economic terms, it increases the PV of pension obligations/liabilities by lowering the discount rate.Sunset Shazzhttps://www.blogger.com/profile/13210148841577062169noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-52870954429670552032013-07-24T16:43:54.111-05:002013-07-24T16:43:54.111-05:00Yes. I was trying to keep it simple for a blog pos...Yes. I was trying to keep it simple for a blog post. What would not change is, you do not earn 8% returns without taking on risk, a lot of risk. Quantify that risk as you will, but there is risk. John H. Cochranehttps://www.blogger.com/profile/04842601651429471525noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-18966715648415025202013-07-24T16:41:16.891-05:002013-07-24T16:41:16.891-05:00Suppose that instead of a 50 year return on a fixe...Suppose that instead of a 50 year return on a fixed investment, we're looking at a 50 year return on a series of 50 annual "contributions." More importantly, suppose each annual contribution is adjusted based on how actual returns have turned out relative to the expected rate of return. This is more similar to actual pensions, where an 'actuarial required contribution' is calculated annually. <br /><br />Would your analysis change? Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-75327723999858277902013-07-24T16:32:38.367-05:002013-07-24T16:32:38.367-05:00One of the prettiest facts about stocks is they ar...One of the prettiest facts about stocks is they are predictable from variables such as P/D and P/E -- and thus not random walks -- but nonetheless the long-term variance is almost exactly the same as the short term variance so they are not, in fact, "safer in the long run." As a analogy, suppose weather were iid but the weather forecast knew the weather one day ahead. You could forecast the weather, but the weather is still iid. Stock returns are uncorrelated in their univariate representation though forecastable in the multivariate representation. John H. Cochranehttps://www.blogger.com/profile/04842601651429471525noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-91165513698810809472013-07-24T16:29:13.699-05:002013-07-24T16:29:13.699-05:00Your implicit assumption of a random-walk for retu...Your implicit assumption of a random-walk for returns does not, I think, fit with the historical data. Andrew Smithers, Robert Shiller, Jeremy Grantham and others have shown that returns have mean reverting tendencies. Please check with your friend Cliff Asness on this, I think he would agree. What I believe Smithers has found is that the longer the period of analysis, the lower the variance of geometrically-compounded returns.Sunset Shazzhttps://www.blogger.com/profile/13210148841577062169noreply@blogger.com