The High Price of Ignoring the Future
Would you rather be given £45 in three days, or £70 in three months? That was the question put to 40,000 people who took part in an experiment conducted by the BBC and the University College of London. Slightly more than half the respondents said they’d prefer to wait 90 days for the bigger payout. Those who opted for the immediate reward were found to be more impulsive in other areas of life, too, said Dr Stian Reimers of the ESRC Centre for Economic Learning and Social Evolution. They were more likely to smoke, engage in extramarital affairs, and be overweight than the delayed-gratification crowd.
…I wonder if it is possible to teach kids and adults how to have more patience? Reimers’ advice doesn’t seem like it would have much of an effect. He said, “Simple techniques can help reduce impulsivity: like imagining how you’d feel about your decision in a year’s time, or trying to avoid making decisions in the heat of the moment.” The problem is, in the heat of the moment, it’s hard to resist making a decision!
The plain vanilla option for financial competition
On the other hand, I see regulatory agencies as about the least “plain vanilla” institutions out there. Try looking at the information provided by a regulatory agency and deciding which of its programs are not delivering value for the money. Are they even trying to explain this to Congress or to the public, much less succeeding? The regulators present their tasks in complex bundles, topped off with lots of rhetoric about how essential the whole thing is. Regulators will go to great lengths to make transparent the benefits of what they do, but not the failures or the costs.
Given that everyone is agreeing sophisticated risk models are worthless in crises, it seems particularly remarkable that regulators allowed some banks to use their in-house models in determining their own capital requirements – since one of the purposes of capital requirements is precisely to provide a cushion that protects banks (and their creditors, and taxpayers) in the event of a crisis. The obvious solution is that regulators should rely on cruder constraints, such as an absolute limit on leverage that banks cannot arbitrage around (one of the recommendations of Treasury’s recent white paper on capital requirements, which we discussed here), or periodic stress tests that estimate how bank asset portfolios will perform in a real crisis.
But there is a more interesting question to ask as well: why did VaR become so popular? It’s important to remember that competition among models is shaped by the human beings who create and use them, and those human beings have their own incentives.
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It’s important to remember that competition among models is shaped by the human beings who create and use them, and those human beings have their own incentives.
This is an important point.
I would say that it's an obvious point too except I have seen it overlooked too many times to feel justified in saying that.
Rob
I think that the first experiment is rather biased to be honest. Anyone who's had even a taste of investing knows that that the 55% interest given on 3 months is ridiculously extravagant. I'd be curious as to see how the results of the experiment would turn out if a more reasonable amount was proposed (like £50)
I think that the first experiment is rather biased to be honest. Anyone who's had even a taste of investing knows that that the 55% interest given on 3 months is ridiculously extravagant. I'd be curious as to see how the results of the experiment would turn out if a more reasonable amount was proposed (like £50)
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