Weekend Links - Thanksgiving Edition

QUOTES OF THE DAY

More technically, to implement the portfolio construction suggested by modern financial theory, one needs to know the entire joint probability distribution of all assets for the entire future, plus the exact utility function for wealth at all future times. And without errors! … We are lucky if we can know what we will eat for lunch tomorrow –how can we figure out the dynamics until the end of time?
   --Nassim Taleb 

Efficiency is Beauty.  -- Mr. Money Mustache

CHART OF THE DAY

RETIREMENT FINANCE AND PLANNING

Joe Tomlinson on Variable Withdrawal and ImprovingRetirement Outcomes, my post on his post...  Optimal asset allocations for variable withdrawal strategies are quite different from the research findings and rules of thumb based on fixed strategies. Indeed, the implications go beyond asset allocation and show, for example, that equity glide paths in retirement are relatively unimportant. 

Savings after Retirement: A Survey, Nardi et al.  NBER and Fed (Chicago and Richmond).  The saving patterns of retired US households pose a challenge to the basic life-cycle model of saving. The observed patterns of out-of-pocket medical expenses, which rise quickly with age and income during retirement, and heterogeneous life span risk can explain a significant portion of US saving during retirement. However, more work is needed to distinguish these precautionary saving motives from other motives, such as the desire to leave bequests. Progress toward disentangling these motivations has been made by matching other features of the data, such as public and private insurance choices. An improved understanding of whether intended bequests left to children and spouses are due to altruism, risk sharing, exchange motivations, or a combination of these factors is an important direction for future research.  

What is synthetic tenure, and why is it important? Benefitnews.com  

Retirement Spending, the RMD, and the PMT() Function. Blanchett, Maciej, and Chen (2012) and Sun and Webb (2012) both studied the RMD rule as a spending option and found it to be a reasonable strategy that roughly approximates more sophisticated attempts to optimize spending... Though these methods are more sophisticated, the underlying PMT formula remains as the philosophical core of the spending recommendations.  [comment: I have posted on this (i.e., PMT()) before in a discussion of Waring and Seigel's Annually Recalculated Virtual Annuity(ARVA)]

Trump, Monte Carloand Insectivores or Simulation is not a plan. Dirk Cotton Monte Carlo simulation was created by physicists. Enrico Fermi used Monte Carlo techniques in the calculation of neutron diffusion in the 1930s. Atoms tend to behave in the same probabilistic ways under the same conditions regardless of emotions, doubts, fears, and biases. People don't.   … Then there is the “one-time event” problem. If Silver was correct and Trump had a one-in-four chance of winning (it was probably much greater than that) then if the election were held one hundred times under identical conditions, Trump would win 25 of them. But the 2016 election was a one-time event. Trump won 100% of the election and Hillary lost 100% of it. Your household's retirement is also a one-time event. [emphasis added] 

The Analytics of a Single-Period Tontine, Sabin and Forman, Abstract: A single-period tontine is an arrangement in which a group of members contribute to an investment pool, and after a fixed period of time, the pool is distributed to those members who are still alive. The distribution is made in unequal amounts based on member death probabilities and contribution amounts. In a companion article we apply the single-period tontine to propose products that we feel have commercial potential. Here, we focus on the analytics. The analysis applies not just to single-period tontines, but also to other arrangements that can be analyzed as a sequence of single-period tontines, such as pooled annuity funds. The core of the paper is the development of formulas for the mean and variance of the random amount that a surviving member receives in a single-period tontine. We use the formulas to resolve an open question about bias in pooled annuity funds and to show practical conditions under which it can be made negligible. We show how the provider can use the formulas to manage the subscription process, determining who is allowed to participate and how much they are allowed to contribute, so that the statistics of the tontine are favorably controlled. We use the formulas to compare mixing different cohorts within a single tontine versus creating a separate tontine for each cohort, finding that mixing cohorts is better because it reduces both idiosyncratic risk and systematic risk.  

The Empirical Frame of the Decision to Annuitize, Moritz Lehmensiek-Starke, University of Muenster.  Microeconomic theory suggests that annuities are favorable because they ensure a steady path of consumption no matter how long the annuitant will live. As a promising attempt to explain why actual annuitization rates are lower than expected, it has recently been argued that consumers do not use such a consumption frame when they decide on annuitizing their wealth. Instead, they might rather apply an investment frame: They evaluate the annuity as a standalone financial product, focusing mainly on its risk and return characteristics and thereby ignoring its insurance value. In this paper, we propose a novel approach to empirically test which frame is actually used by consumers. More precisely, we argue that uncertainty about one’s subjective prospects of survival should have opposing effects on the decision to annuitize depending on the frame. In a consumption frame, an annuity provides a hedge against the financial risks of an uncertain lifetime whereas in an investment frame uncertainty about one’s future survival translates directly into financial risk. Using field data from the Health and Retirement Study, we show that respondents who have more precise beliefs about their chances of survival tend to annuitize larger parts of their wealth. We therefore find empirical support for the investment frame.  

MARKETS AND INVESTING 

In Calm Markets Should We Buy “Cheap” Put Protection?  AlphaArchitect. 

• the [Volatility Risk Premium] spread is not insignificant. The Israelov and Nielson paper observes that from 1990 through 2014, the VRP averaged 3.4%, and was positive 88% of the time. That’s not only weird, but also has significant implications for strategies that use options…
• This is remarkable. Why should you pay a 2% fee to maintain a long vol position[long put], which doesn’t really offer much in the way of protection? It appears that, on average, long volatility exposure is very costly, compared with the meager benefits associated with it…
• in order to break even on a protective put strategy with 5% out-of-the-money options, a 1987-type black swan would have to occur every 21 years…
• The authors suggest that if people have a strong view on an imminent market correction that they implement that view by reducing equity exposure, or by purchasing insurance assets that pay you to hold them. Accordingly, paying through the nose for a option-based hedging program that loses money for years while waiting for a big payoff that may never materialize is not the way to go.

[comment: this link is an example of why I try to have systematic exposure to short volatility by way of a short option strategy.  The strategy has positive return expectations both academically speaking as well as in practice along with, if it's implemented right, non-correlation.  That makes it a discrete "alternative" asset class that can add to portfolio efficiency.  There are some ETFs out there that do this and, though I haven't looked, maybe some mutual funds(?).  I do it on my own so that I have more control over implementation and risk.  It is not for the faint-of-heart.  Rather than typical trading where small risks are taken in a continuous sequence for the hope of big gains of some low-ish probability to yield an edge greater than zero, this strategy requires one to continuously take big risks in exchange for small gains of high-ish probability in order to yield an expectancy > 0.  Similar outcome if done right but with a dicer (my opinion) path in between.] 

Still Not Cheap: Portfolio Protection in Calm Markets, Israelov & Nielsen, AQR.  It is well-known that portfolio insurance is expensive on average, but what about in calm markets? History suggests it still is. We investigate the relationship between option richness and volatility across ten global equity indices. Option prices may be low, but their expected values tend to be even lower. 

How Bad Could Bond Market Losses Get? Ben Carlson.  there’s something that many investors forget when discussing the implications from rising rates on bond returns. Namely, that higher yields are eventually a good thing for your bottom line…A bad year in the high quality, intermediate maturity bonds is typically the same as a bad day or week in the stock market…[but]… Planning for fixed income assets is not as easy as it once was…  

Limited Marital Commitment and Household Portfolios, Addoum et al.  Cornell, LBS, U. Alberta.  This paper examines the link between marital decisions, consumption, and optimal portfolio choice in a life-cycle model with limited marital commitment. Without full commitment, individual income shocks lead to renegotiation between spouses, altering relative bargaining power and endogenously generating time-varying risk aversion at the household-level. Consequently, changes in relative income are associated with significant shifts in household portfolios. We find strong support for this prediction using data from the PSID. The model can also rationalize the link between marital transitions and portfolio allocations observed in the data. Finally, the risk-sharing benefits of marriage imply a positive link between wealth and risky asset holdings across households.  

Portfolio Panic - How to Not Ditch Your Investment Plan, NewFound Research.  there are many approaches to investing that have proven track records of success.  Each has its own strengths and weaknesses and there is no holy grail.  Success requires developing a thoughtful plan that is backed by both theory and data and then having the discipline to stick with that plan.

ALTERNATIVE RISK

Foreword to Ed Thorp’s Memoirs (A Man for All Markets), medium.com, Nassim Taleb.  It is the dosage of your betting –not too little, not too much –that in the end matters.  …  Having an “edge” and surviving are two different things: the first requires the second.

New Book Shines Light On Momentum, ETF.com  [comment: just bought; about half way through.]  

Inside a Moneymaking Machine Like No Other, Bloomberg.  The "manhattan project" of finance? [story about Renaissance Technologies]  

Does Risk Parity Maximize Risk-Adjusted Returns? markovprocesses.com 

Great Minds Agree To Disagree On The Source Of The ValueInvesting Premium, Wesley Gray.  Bottom line: Great minds can disagree on the explanation, but nobody can dispute the empirical fact that value stocks have outperformed growth stocks by a wide margin over time. One would also be remiss in suggesting that exploiting the edge in value investing is easy — it’s highly volatile and needs to be pooled in a broader portfolio, ideally alongside momentum.  

Review: Quantitative Momentum, CharlesSizemore.com Gray and Vogel spend much of the rest of the book testing assorted momentum strategies, and while I will spare you the pages of data tables, suffice it to say that, sliced any number of ways, momentum strategies can add serious alpha.    [comment: about half way through the book myself]

SOCIETY AND CAPITAL

How to raise house prices and inequality, John Cochrane.  So the effects are not just to raise house prices -- they are to increase inequality, reduce opportunity, especially for low skill and low income people, and reduce the economic vitality of the region. 

Renewable energy is seeping into small-town America, Vox.  What’s more, unlike the abstractions involved in climate, clean energy is real, tangible, and — perhaps most important of all — commercially viable. There are many things that divide Americans, but they are generally united on the benefits of making money. 

Financial Literacy Is Still Abysmal Everywhere, WSJ.  A new OECD survey of 30 countries shows few people can perform basic financial calculations or understand simple investment rules  

A long-accepted link between unemployment and economicgrowth is now being questioned, with important implications for the economy. AIER.  It appears that companies lay off workers in the face of GDP fluctuations much more readily than they used to. The wisdom of doing so may be debatable, but this behavior is likely to continue. Expect employers to be willing to lay off people in tough economic times. Ensure that you have sufficient savings to get through such a situation, should it happen to you.  

The Future of Military Technology is Intense, Visual Capitalist.  Today’s infographic comes from Futurism, showing the technological advancements we can expect to materialize in the battlefield over the coming decades.  

Health savings accounts: Another conservative 'reform'nostrum that chiefly benefits the rich, LA Times.  [comment.  Discussion is ok, maybe a little tendentious but this is the LA Times after all]

Dallas Policeand Fire Pension Fund Beset by Withdrawals, WSJ.  The revolt by members of the $2.27 billion Dallas Police and Fire Pension Fund offers an extreme case of what can happen when a pension wagers on lucrative returns to cover funding shortfalls…“We’ve never seen anything like this,” said Detective Frederick Frazier, president of the Dallas Police Association…“I have not seen this type of run on a fund anywhere else in the country,” said Alicia Munnell, the director of Boston College’s Center for Retirement Research. 

Paying Bone Marrow Donors, Tim Taylor, is bone marrow an organ, or is it more similar to blood plasma? The answer to the question is a matter of life and death. About 275 American die every year because they have a disease like leukemia or certain kinds of anemia that sharply reduces the ability of their bone marrow to generate red blood cells--and they can't get a transplant. Offering payment of perhaps $2,000 to donors could potentially save those lives. Samuel Hammond makes the case in "Bone Marrow Mismatch:How compensating bone marrow donors can end the transplant shortage and save lives," written as a discussion paper for the Niskanen Center (November 15, 2016). 

The Plague of Long-Term Unemployment in Europe, Tim Taylor.  American readers: can you imagine the social turmoil in the US if the unemployment rate has been above 10% for the last seven years, instead of peaking at 10% back in October 2009 and falling down to about 5% by a year ago in fall 2015? Can you imagine if half of these unemployed had been looking for work for more than a year? Consider the difference, and you'll have a better sense of why the EU is struggling to have much appeal to the European public.  

Dakota Access Pipeline in Context

Do Rises in Oil Prices Mean Rises in Food Prices? St Louis Fed.  Prices for agricultural commodities have been rising over the past 10 years. During the same period, crude oil prices have also increased substantially. The simultaneous rise in the price for agricultural inputs and crude oil has raised new questions about whether an increase in oil prices translates to increased food prices, an occurrence called pass-through…These findings suggest that if there is any link between increased food and oil prices, it is extremely small. 

Is healthy food a luxury for low-income households in the United States? Tyler Cowen.  findings suggest that there are important trade-offs in policies that subsidize food expenditure because these policies allow low-income households to purchase more of the healthy as well as the unhealthy food products.  

Is Indexing Worse Than Marxism? Burton G. Malkiel, WSJ Opinion.  Index funds have long been ridiculed by active mutual-fund managers. But with index funds outperforming more than 80% of their active peers over the past five- and 10-year periods, and investors pulling hundreds of billions out of actively managed funds and putting that money into index funds, it’s hard to claim that passive index investing produces mediocre results. So a new critique has emerged. It is now alleged that index funds pose a grave danger to the stock market and overall economy.