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Background on the Nobel in Economics
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Areas with Implications for Actuarial Analysis
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Financial Economics
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Asymmetrical Information
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Behavioral Economics/Finance
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Econometrics
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Valuable Insights/Observations – part 1
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Valuable Insights/Observations – part 2
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Background on the Nobel in Economics
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Financial Economics
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Markowitz - 1990 for work in the late 1950s
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Modigliani & Miller – 1990 for work in the 1960s
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Sharpe- 1990 for work in the 1960s
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Scholes and Merton – 1997 for work in the 1970s
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Asymmetrical Information
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Mirrlees – 1996 for work in 1970s
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Akerlof – 2001 for work in mid to late 1960s
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Spence – 2001 for work in early 1970s
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Stiglitz – 2001 for work in mid 1970s
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Behavioral Economics/Finance
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Kahneman – 2002 for work in the 1970s
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Econometrics
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Trygve Haavelmo – 1989 for work in the 1940s
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Engle – 2003
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Granger – 2003
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Financial Economics
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Markowitz - microfinance portfolio theory
 Mean variance
 Efficient frontier recognizing covariance of securities
 Quadratic objective function
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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
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Sharpe – market focus - CAPM
 Systematic vs. Diversifiable risk
 Risk premium based on covariance with market return
 Market portfolio and lending/borrowing @ risk free rate
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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
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Mirrlees – optimal income taxes
 Moral hazard
 Disincentive to work to avoid taxes
 Hide income to avoid taxes
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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
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Spence – better informed incur costs to improve outcomes
 Signaling
 Factory mutuals and fire protection services
 Auto warranties -
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Stiglitz – poorly informed extract info from better informed
 Screening
 Insurance deductibles
 MGAs and retentions
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Behavioral Economics/Finance
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Kahneman – decision making under uncertainty/irrational behavior
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Expected utility is not entirely convex
– Different response to the same problem depending on how it’s presented
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Loss aversion
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Prospect theory
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Ignore/overlook prior information
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Econometrics
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Trygve Haavelmo – made econometrics probabilistic
 Statistical inference/hypothesis testing
 Simultaneous interactions/identification problem
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Engle – changing volatility over time
 autoregressive conditional heteroskedasticity (ARCH)
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Granger – time series with common trends
 cointegration
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Valuable Insights/Observations
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Friedman – policy lags/positive vs normative
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Lucas – rational expectations
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Arrow – theory of insurance
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Simon – satisficing vs. maximizing
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Tobin – Tobin’s Q/risk free asset vs market portfolio
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Heckman – selection bias
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Fogel & North – technology and development
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Samuelson
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Valuable Insights/Observations
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The standard model:
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Self interested rational behavior
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Full information
– Akerlof’s “Market for Lemons” story
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Article rejected twice as being trivial
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Article rejected as undermining standard model
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Article finally accepted
– Today’s models are varied and include:
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The standard model
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Models to explain behavior with incomplete and asymmetrical info
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Behavioral finance – irrational exuberance
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Auctions (Vickery & Smith)
– Measuring “happiness”
– How effective are today’s actuarial methods?
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Are they seasoned or just stale?
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