Knowing and Making

This article on pensions from the Economist made me wonder about something. It used to be that people in the UK were compelled to buy an annuity on retirement with their pension savings. Well, almost compelled - if they took it out as cash, they'd have to pay tax on the lump sum. So if I saved for ten years at 22% tax relief, and I then withdrew the sum, I'd have to pay 22% tax on the withdrawal. Fair enough - the idea of pension tax relief is to encourage people to build up an income which would stop them having to draw on state benefits in retirement. If I can withdraw the cash, as if it were a standard savings plan, then the tax treatment should be the same as if I'd saved the money outside of a pension. But could this be used to game the system? What if today - with top tax rates at 50% - I think that the income tax rate is higher than its long-term average. Then I might save in a pension now, intending to withdraw later when tax is cut back to 40% or lower -...

I presented this paper today at the conference of the Cass Behavioural Finance Working Group . In summary, it replaces the concept of "news" or "information" in the Efficient Markets Hypothesis with a model of beliefs , reflecting the idea that nobody in a market has objective, indisputable knowledge  about anything, only beliefs of different levels of confidence. Slides here ; will tell you more later.

A superb little piece from Steven Landsburg . I forget sometimes what a good writer - and what a good economist - he is. This one is about whether it's right to retrospectively punish bad, but legal, behaviour. The same argument could very well be applied to the payment of large bonuses by banks. There are two competing principles here. The first principle is: Nor shall private property be taken for public use without just compensation, a principle enshrined in our Bill of Rights... But here's the countervailing principle: Bad behavior ---even legal bad behavior---should be punished eventually, because that precedent deters future bad behavior. If that principle were applied consistently and predictably, firms might not have overinvested in the wrong technologies [ or overpaid their risk-seeking employees? ] to begin with. This speech by James Montier is a very nice, funny and persuasive argument against the EMH. Of course being funny and persuasive can hide many logical flaws...

When the following post from Mark Thoma came up in my RSS feed: Reality Pricks Corn Ethanol's Bubble for some reason I first parsed "Corn" as the verb in the sentence. I don't know quite why my brain responded that way...I am not sure what corning would be, and as for a "reality prick"? A few other links before I go out for the evening: Mark's contribution to the Lucas roundtable at the Economist (do click through to see the other articles, including Tyler Cowen who seems to be getting good at identifying a nice balance point at the fulcrum of many economic debates) Richard Thaler's FT article (one of many on the EMH in the last few weeks) Another EMH discussion - excerpted from John Quiggin's forthcoming book - at Crooked Timber What looks like a fascinating book by Kenneth Arrow (h/t Paul Krugman) The "Cripes" growth model from Worthwhile Canadian Initiative. A very neat idea and entertainingly written but I think it misses some ...

A perceptive article by Tony Jackson in the FT illustrates two theoretical points I'll be developing in more detail over the next few weeks. First, he equivocates about the efficient markets hypothesis (EMH): When we make a killing in a rising market, we dwell on our own smartness rather than the irrationality of prices having been too low. This is a key point to understand in markets - especially illiquid ones such as property. Some commodities tend to exhibit long-term bear and bull markets. Residential property in the UK showed a consistent rising trend from the early 1990s until 2007. It's hard to argue, even having seen subsequent falls, that this obeyed the "random walk" theory of the pure EMH. Instead, it's more convincing to posit that there was a "correct" efficient value - perhaps the 2004 or 2005 price? - and that most people from the mid-90s onwards could see that the correct value was higher than the current price. However, natural caution,...

Andrew Lo, writing in the FT , says: ...human behaviour is hardly rational, but is driven by "animal spirits" that generate market bubbles and busts, and regulation is essential for reining in misbehaviour. Regular readers won't be surprised to see me agreeing with this, and indeed I have a proposal for how that regulation could work. However I am suspicious about any theory which does not make testable predictions, and I fear that Lo's "adaptive markets hypothesis" may fall into this category. This "Adaptive Markets Hypothesis" (AMH) - essentially an evolutionary biologist's view of market dynamics - is at odds with economic orthodoxy, which has been heavily influenced by mathematics and physics...The formality of mathematics and physics, in which mainstream economics is routinely dressed, can give outsiders a false sense of precision. ...fixed rules that ignore changing environments will almost always have unintended consequences...The only ...