Wednesday, 29 July 2015

I Thought Better of 'The Economist' Than This

Yesterday CU posted on a report covered in the Grauniad based on ludicrous calculations.

Here's another, featured in the same place, this time flying the colours of the Economist Intelligence Unit (and oddly sponsored by Aviva, presumably to provide top-cover for some bizarre new policy direction they are taking).  It pupports to establish that the Cost of Doing Nothing - about climate change, naturally - is as follows:
"value at risk to manageable assets from climate change calculated in this report is US$4.2trn, in present value terms.  The tail risks are more extreme; 6°C of warming could lead to a present value loss worth US$13.8trn, using private-sector discount rates.  From the public-sector perspective, 6°C of warming represents present value losses worth US$43trn—30% of the entire stock of the world’s manageable assets"
Oo-err, missus.  It runs to 63 pages but I can't recommend you spend the time.  However, as part of the usual C@W service to readers, here are a few comments.

1.  Gross mis-use of 'VaR'

The report states (correctly): "A core responsibility of asset managers and institutional investors is to manage risk, and the most commonly employed measure to assess it is value at risk (VaR)."  Just so, but the calculation of VaR as understood (and in the finacial world it is indeed well-understood, check google to see the wealth of serious work done on this metric) absolutely cannot sustain a horizon-period of 85 years. Most practitioners wouldn't trust it much beyond 8.5 days (- find me a company report citing VaR beyond 5 days).  Nicholas Taleb often writes as though he wouldn't trust it at all.

But they are clearly inviting us to accept it in the technical sense that the 'VaR' moniker is regularly employed for (as well, perhaps, in an ordinary-language sense for those who have no inklining it is in fat a technical term).   It is hard for a non-practitioner to grasp what violence has been done to the underlying concepts to push out VaR that far.  It's a bit like saying to a patient:  we need you to hold your breath for ten seconds while we do this test.  Good: now hold it for ten hours.

What they've done mathematically might have some ultra-qualified, very abstruse 'meaning'.  But they are trying to leverage the broad, intuitive acceptance of VaR as a financial metric: and VaR it ain't.

2.  Ludicrous scenarios / counterfactuals

A related issue is the craziness of projecting either scenario - a world without climate change (base case) and a do-nothing world of climate change (in varying degrees of temperature-rise) - on a continuous basis, with nice smooth curves.  One of the reasons VaR is properly limited to what might be lost over a few days is that much beyond that, (a) empirical data shows that the maths breaks down / ceases to be valid; and (b) a massive factor behind this is that people react to developing situations and re-optimise their positions.  Feedback kicks in.  So nothing in the human world carries on in smooth curves (check the price of oil since 1972 for an illustration).  Sometimes - retrospectively - 'secular trends' are identified, and how long do they last?  Only the benign ones last 85 years.

Why is it to be imagined that anything would drag on getting worse and worse for 85 years?  I don't mean "- because obviously we will all agree to install more windfarms at the next Paris Conference", I mean because (if you really believe this stuff) something will fundamentally bust a great deal sooner than 85 years.  (And I understand, of course, that a believer might advocate 'acting', for that very reason - but please don't tell us the financial incentive to do so is measured by an 85-year model.)

The way the world really works is, if something really bad is actually happening then a war breaks out (or similar extreme reaction) - in other words, a discontinuity results, much sooner than 85 years into the affair.  Do wars destroy wealth?  Well they do, and more - strongly to be avoided where possible.  But have a look at how WW2 turned out for the USA.  Or the aviation industry.  Or nuclear science.  Things change, and change a lot.

3.  Why call this stuff 'Climate VaR'?

Why not 'over-population VaR'?  It's every bit as good a conceptual diagnosis of what they think is going on.

I really thought better of the Economist than this.

ND

20 comments:

Steven_L said...

Isn't this just the logical progression of a political consensus that believes the government should do what it can to ensure rising asset prices?

dearieme said...

I gave up the Economist in my twenties when I realised it was Always Right About Everything.

Bill Quango MP said...

85 years ago today

- Pluto discovered.
- Very nascent form of deep freezing food discovered by Mr Birdseye
- USS Nautilus launched. First modern submarine.
- Synthetic rubber invented
- Neoprene invented
- Chrysler Building, world's tallest then, opens.
- TV domestic broadcasting begins in USA
-1st non-stop flight from Europe to USA
-Flashbulb patented
- First radiosonde sent up balloon.

All these are ancient discoveries. Mostly of technology that has since been superseded. Synthetic rubber looks the most revolutionary on the list. That has pretty much replaced conventional rubber throughout the world. Looking out from 1930 what could you realistically predict?
In 1930 Babe Ruth signed a $160,000 2 year contract that was widely thought to be the

And that's 1930. A very poor year for doing anything in the teeth of the great crash of 1929.

Climatewise just few
22 people killed in a hailstorm in Greece in May 1930-
43*C in Delaware - State record for july.
46* Tennessee - USA record temp.
-37* in Illinois in feb
645 earthquake shocks in Tokyo in a single day.

Blue Eyes said...

Why would denizens of Kepler-452b care what the weather is like on Earth?

Sackerson said...

If "climate change" is really happening, I'd have thought the putative financial cost would be a relatively minor concern. This is like one of those spoof Daily Mail headlines bemoaning the effect on house prices.

CityUnslicker said...

Brilliant VaR piece ND. What is the point of taking such a stupid view and expounding on it. I may as well have a fear of aeronautical porcine assault for all the good it will do.

Worse still the newspapers just print any old rubbish that some tosser has put together that spouts their 'line'

welcome to the world of a Corbyn Socialist per chance?

Electro-Kevin said...

This is Blairism at work.

Greenism is the modern CND. Effectively socialist redistribution through taxation on consumption.

We know it's bunk because they keep increasing our population whilst telling us to consume less - to meet green targets.

Perhaps such long term VaR is taken seriously because powerful capitalists have learned to exploit taxpayer subsidised capitalism - as we have in Britain.

Electro-Kevin said...

CND failed spectacularly. To the point that the socialists were proven so wrong that they could no longer use it as their trump. Now they have AGW instead.

The UK economy is so based in redistributive taxation that capitalists have learned to embrace it and take Greenism seriously. Not only is it green it is seen as virtuous and clean too.

Sackerson said...

EK, I have some sympathy for CND (ducks): mass murder of innocent foreigners to punish their safely hidden leadership seems immoral. The balance of terror may have worked so far but Mexican standoffs aren't guaranteed to end peacefully, or my viewing of spaghetti Westerns has been wasted.

andrew said...

Am a long time subscriber and had great respect for the economist, but once it did some articles on subjects I know something about the realisation came that they don't know more than god, just a bit more than a taxi driver or a bloke down the pub.

The thing is that even imperfect it beats most other sources of info.

I hope it does ok after it is sold.


andrew said...

oh yes, it think the post is really prodding mathiness

Nick Drew said...

Andrew - thanks indeed for that mathiness link, you've given me a new and very apt label for a phenomenon I despise; better not start me on its manifestations in econometrics and forecasting ...

(though I'm not entirely happy to be on the same side as Stiglitz and Krugman, as it seems)

Nick Drew said...

what I would say about the Economist, however, is that the writing is good, you'll rarely see so much communicated so deftly (whatever you think of the content)

hovis said...

So:

(i)The Economist a corporatist rag printing the fashionable memes of lobbyist research

(ii) A mutated form of the ever unreliable Cost Benefit Analysis used to push agenda's

Who'd thunk it eh?

Electro-Kevin said...

Sackerson - Nuclear deterence wasn't optional. It still isn't.

Sackerson said...

E-K: get your point. Still inherently an immoral thing, I think.

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