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The Actuary The magazine of the Institute & Faculty of Actuaries

Erratic expectations


I was interested to learn from Alex Waite’s July article (bit.ly/AnimalSpiritsAW) there is an Economic Modelling Group aiming at improving forecasting of economic outcomes. I wish this the best of luck, but would not be surprised if the results prove inconclusive.

There is a major problem with the theory underlying financial and economic modelling, in that conventional thinking is based on linear behaviour, normal distributions, and rational expectations, leading to orderly outcomes. As pointed out over 50 years ago by the late Benoit Mandelbrot, economic and market outcomes tend much more to reflect non-linear behaviour, fat-tailed distributions and erratic expectations. It may therefore be necessary to go back to the most basic principles in search of a sounder basis for modelling.

The risk is that this could merely lead to a conclusion that the uncertainties are greater than most previously understood or appreciated, but that there is insufficient stable ground on which to base erection of better alternatives. Still, it may be worth a try.

W John Bishop 

14 July 2017