Mental time travel and the valuation of financial investments: analysing five biases that cause pricing anomalies
David Blake and John Pickles
Abstract
Purpose
The purpose of this paper is to analyse five biases in the valuation of financial investments using a mental time travel framework involving thought investments – with no objective time passing.
Design/methodology/approach
An investment’s initial value, together with any periodic funding cash-flows, are mentally projected forward (at an expected rate of return) to give the value at the investment horizon; and this projected value is mentally discounted back to the present. If there is a difference between the initial and present values, then this can imply a bias in valuation.
Findings
The study identifies (and gives examples of) five real-world valuation biases: biased funding cash-flow estimates (e.g., mega infrastructure projects); biased rate of return projections (e.g., market crises, tech stock carve-outs); biased discount rate estimates (e.g., dual-listed shares, dual-class shares, short-termism, time-risk misperception, and long-termism); time-duration misestimation or perception bias when projecting (e.g., time-contracted projections which lead to short-termism); and time-duration misestimation or perception bias when discounting (e.g., time-extended discounting which also leads to short-termism). More than one bias can be operating at the same time and we give an example of low levels of retirement savings being the result of the biased discounting of biased projections. Finally, we consider the effects of the different biases of different agents operating simultaneously.
Originality/value
The paper examines key systematic misestimation and psychological biases underlying financial investment valuation pricing anomalies.
Keywords:
financial investment valuation, thought investment, Mental time travel, Rational and irrational expectations, Projecting, Discounting, Biases, Heterogeneous agents.
The Impact of Covid-19 on Higher-Age Mortality.
Andrew J.G. Cairns, David Blake, Amy R. Kessler and Marsha Kessler.
Abstract
We propose a simple model for accelerated deaths that draws on the observation that many of those who died from Covid-19 were often, but not always, much less healthy than the average for their age group; further, the vast majority who died were over the age of 50. The model predicts that, in the absence of additional secondary effects, the impact on the life expectancy of survivors (the anti-selection effect) will be very small, and that the degree of impact depends on the average years of life lost by those who die from Covid-19. The philosophy underpinnning the model is supported by reference to both all-cause mortality by age and all-cause mortality by Socio-economic deprivation group. In combination, these support a proportionality link between Covid-19 mortality and individual frailty or death rates. The Accelerated Deaths Model is consistent with the mortality experience associated with respiratory diseases over the period 2013-15 and with past seasonal influenza epidemics.
Keywords:
Covid-19, all-cause mortality, frailty, co-morbidities, deprivation, Accelerated Deaths Model, Proportionality Hypothesis, anti-selection.
Incorporating Vitagions into Stochastic Longevity Models
Maria Carannante, Valeria D’Amato, Cinzia Di Palo, Maria Sole Staffa
Abstract
Assessing mortality dynamics remains a central challenge in demographic, actuarial, and public health research, primarily due to the difficulty of producing reliable forecasts. This complexity is particularly highlighted during periods with large deviations from long-term trends, such as sudden mortality increases due to pandemics or decreases driven by medical and technological breakthroughs. In this context, we address the need for enhanced stochastic models that integrate sudden and significant mortality improvements, termed “vitagions”, into forward looking forecasts. While foundational stochastic mortality models, such as those developed by Cairns et al. (2006b,a, 2009), provide a robust basis, they do not explicitly account for exogenous, forward-looking innovations. Building on this literature, we incorporate vitagions, defined as stochastic agents of mortality improvement associated with biomedical innovation and other external shocks (Woo (2014); Carannante et al.
(2024)). Vitagions capture health-related advances, from disease prevention to advanced therapies, that can trigger persistent and one-sided mortality reductions.
This paper makes one main contribution. We extend the Lee–Carter (LC) and Cairns-Blake-Dowd M6 (CBD M6) models by adding an exogenous innovation covariate that captures age-specific sensitivity to a detrended indicator of pharmaceutical innovation (constructed from FDA/EMA approvals), and we address identifiability through explicit normalisations and orthogonality constraints. An empirical analysis employs data from the U.S., France, and Italy, which show different historical mortality patterns. Scenario-based simulations deliver clearer period dynamics while preserving baseline age profiles.
Keywords: stochastic mortality models; vitagions; longevity risk; Lee–Carter; Cairns–Blake–Dowd; medical innovation.
Pension Funds and Sustainability
David Blake
Abstract
This article looks at the problem of climate change and sustainable development solutions to this problem, focusing o the role that pension funds can play in supporting sustainability
Covid‑19 mortality: the Proportionality Hypothesis
Andrew J. G. Cairns, David Blake, Amy Kessler, Marsha Kessler & Rohit Mathur
Abstract
We introduce and provide evidence to support the Proportionality Hypothesis which states that Covid-19 infection fatality rates are approximately proportional to all cause death rates by age and subgroup (e.g., socio-economic class). We also show that vaccination played a very significant role in preventing people infected with Covid-19 from needing to be hospitalised, since it reduced the average severity of an infection. Death rates involving Covid-19 were very significantly lower for people in the fully vaccinated group compared to the unvaccinated group. During the pandemic, death rates from other causes were in some cases reduced (e.g., fu and pneumonia), in some cases unchanged (e.g., lung cancer) and in some cases elevated (e.g., heart disease). We discuss the implications of our findings both for potential adjustments to extrapolative mortality models which allow for future pandemics in a way that is consistent with the Proportionality Hypothesis and for insurance companies in terms of both modelling extreme scenarios and the design of mortality catastrophe bonds.
Keywords
Covid-19 mortality · The Proportionality Hypothesis · Infection fatality
rate · All-cause mortality · Biological frailty · Relative frailty · Age · Deprivation
The United Kingdom Examining the Switch from Low Public Pensions to High-Cost Private Pensions.
David Blake
Introduction
The United Kingdom is one of the few countries in Europe that is not facing a serious pensions crisis. The reasons for this are straightforward: Its state pensions (both in terms of the replacement ratio and as a proportion of average earnings) are among the lowest in Europe; it has a longstanding funded private pension sector; its population is aging less rapidly than elsewhere in Europe; and it governments have, since the beginning of the 1980s, taken measures to prevent the development of a pension crisis. These measures have involved making systematic cuts in unfunded state pension provisions and increasingly transferring the burden of providing pensions to the funded private sector. The United Kingdom is not entitled to be complacent, however, because there remain some serious and unresolved problems with private-sector provision.
This paper reviews the current system of pension provision in the United Kingdom, describes and analyzes defects in the Thatcher-Major governments’ reforms that brought us to the present system, examines and assesses the reforms of the Blair government, and then identifies the problems that remain unresolved and how those problems might be addressed.
The paper ends with an explanation of how the United Kingdom has been able to introduce changes relatively peacefully when attempts by continental European countries to reform their pension systems have frequently led to riots in the streets.
Longevity Risk and Capital Markets: The 2022-23 Update
David Blake and Johnny Li
Abstract
We discuss the papers presented at Longevity 17: The Seventeenth International Longevity Risk and Capital Markets Solutions Conference that was held online on 12-13 September 2022. We also discuss 1) the development of the longevity risk transfer market since it started in 2005-06 and 2) key factors that will affect the future of the market: peak cash flows; the volatility of life expectancy trends; population aging; the aging process and anti-aging treatments; preventative health care and later life wellness; artificial intelligence, machine learning, robotics, and quantum computing; the implications of global aging for financial markets and economic growth; and climate change and sustainable development.
Longevity Risk and Capital Markets: The 2021-2022 Update
David Blake, Malene Kallestrup-Lamb and Jesper Rangvid
Abstract
This Special Issue of the Journal of Demographic Economics contains 10 contributions to the academic literature all dealing with longevity risk and capital markets. Draft versions of the papers were presented at Longevity 16: The Sixteenth International Longevity Risk and Capital Markets Solutions Conference that was held in Helsingør near Copenhagen on 13-14 August 2021. It was hosted by PerCent at Copenhagen Business School and the Pensions Institute at
City, University of London. Longevity risk and related capital market solutions have grown increasingly important in recent years, both in academic research and in the markets we refer to as the Life Market, i.e., the capital market that trades longevity-linked assets and liabilities.1 Mortality improvements around the world are putting more and more pressure on governments, pension funds, life insurance companies, as well as individuals, to deal with the longevity risk they face. At the same time, capital markets can, in principle, provide vehicles to hedge longevity risk effectively and transfer the risk from those unwilling or unable to manage it to those willing to invest in this risk in exchange for appropriate risk-adjusted returns or to those who have a counterpoising risk that longevity risk can hedge, e.g., life offices and reinsurers with mortality risk on their books. Many new investment products have been created both by the
insurance/reinsurance industry and by the capital markets. Mortality catastrophe bonds are an early example of a successful insurance-linked security. Some new innovative capital market solutions for transferring longevity risk include longevity (or survivor) bonds, longevity (or survivor) swaps, mortality (or q-) forward contracts and reinsurance sidecars (also called strategic reinsurance vehicles). The aim of the International Longevity Risk and Capital Markets Solutions Conferences is to bring together academics and practitioners from all over the world to discuss and analyze these exciting new developments.
Nudges and Networks: How to use Behavioural Economics to Improve the Life Cycles Savings-Consumption Balance.
David Blake
Abstract:
Many people find it difficult to start and maintain a retirement savings plan. We show how nudges can be used both the encourage people to save enough to provide an acceptable standard of living in retirement and to draw down their accumulated pension fund to maximize retirement spending, without the risk of either running out of money or leaving unintended bequests. Networks can help too, particularly employer-based networks. However, the nudges and networks are more likely to be effective if they have legislative backing and support.
Keywords:
nudges; networks; behavioural economics; life cycle savings-consumption; Save More Tomorrow (SMART) plans; Spend Optimally Throughout Retirement (SPEEDOMETER) plans.
JEL Classification:
D91
Good Practice Principles in Modelling Defined Contribution Pension Plans.
Kevin Dowd & David Blake
Abstract
We establish 16 Good practice principles for modelling defined contribution pension plans. These principles cover the following issues: model specification and calibration; modelling quantifiable uncertainty; modelling member choices; modelling member characteristics, such as occupation and gender; modelling plan charges; modelling longevity risk; modelling the post retirement period; integrating the pre- and post-retirement periods; modelling additional sources of income, such as the state pension and equity release; modelling extraneous factors, such as unemployment risk, activity rates, taxes and welfare entitlements; scenario analysis and stress testing; periodic updating of the model and changing assumptions; and overall fitness for purpose.
Keywords:
defined contribution pension plans; PensionMetrics methodology; OECD Roadmap for the Good Design of Defined Contribution Pension Plans; EOPA Good practices on Information Provision for DC Schemes: Enabling Occupational DC Scheme Members to Plan for Retirement
JEL Classification:
C15; C18; C63; C68; D14; D91.
