January 24, 2015

Correspondence between actuarial scientists and USS trustees very revealing

In November my colleagues Jane Hutton and Saul Jacka and a group of other leading statisticians, financial mathematicians and actuarial scientists wrote to the USS trustees with a detailed critique of the assumptions they were proposing to make for the valuation.

The reply from USS chief executive Bill Galvin, is very worrying in the thinking it reveals. The rejoinder from the experts is here. (It is also published on Jane Hutton's webpage.)

Bill Galvin reveals a market-fundamentalist perspective. He says that calculations of some of the parameters that underly the deficit - like deriving inflation expectations from market prices - are 'objective' and therefore superior to anything else. One should use market-based measures to forecast rather than observed trends. This is insisting on a theoretical model of how the market works and is akin to a religious belief.

What is particularly worrying is that this view of the world is very individualistic. It focusses on the fund alone as a single entity in relation to the market which is seen as operating independently. But in reality the market comprises many other investors. If they all follow the best practice that Bill Galvin advocates in treating market prices as 'objecitve', then who is there left to make the market work? For a market to work the way thhis efficinet markets theory tells us it should it is necessary for all market participants to behave as 'economic man'. They should be actively looking for investment opportunities at all times, buying and selling assets to achieve the optimal portfolio.

Galvin's approach therefore embodies a fallacy of composition. If all market participant behave as the USS under Bill Galvin - assuming the market to be efficient - then the market will surely not be efficient.

The investment strategy therefore is little more than following the herd. Marlet prices will have a large arbitrary component reflecting factros such as 'irrational exuberance' or random factors.

I thnk this is fundamental. It is a symptom of a common form of myopia that curently is endemic in much economics: to see the world as if it consists a single individual - household or firm - like Robinson Crusoe's island. This is the source of a many of the problems that have affected macroeconomics that have been widely discussed. (See for example John Kay.)


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