Valuation of no-negative-equity guarantees with a lower reflecting barrier

This draft paper develops some of the thoughts in my earliest blog post on NNEG valuation.  ABSTRACT: If the general level of house prices falls a long way, policymakers may introduce new policies which seek to support prices. This paper considers the effect of such interventions on the valuation of no-negative-equity guarantees (NNEG) in equity release mortgages. I … Read more

Fractional shares and dodgy pie charts

TLDR: When fractional shares are ranked and grouped in buckets, any ratio of successive bucket means >0.5 is suspect. ————– Listening to this interview with John Hempton reminded me of his forensic scepticism about the following pie chart, taken from an investor presentation about the pharma company Valeant. John wrote (in 2014, when Valeant was still riding high) that the chart looked implausible … Read more

NNEG: Rental yields versus imputed yields

My Kent colleague Radu Tunaru’s recent report for the Institute and Faculty of Actuaries (IFoA) on valuation of no negative equity guarantees was discussed at a meeting at Staple Inn last Thursday.  A controversial element was the adjusted rental yield calculation of 0.2 x 5% = 1%, where 5% is the observed gross yield on rented properties and 0.2 … Read more

Black-Scholes: my “Buffett mistakes”

A confession: I am the actuary who disagreed with this post by Dean Buckner, a former PRA official, which asserts that the Black-Scholes formula gives a good valuation of an option under the assumption of mean reversion in prices. In a follow-up post he said my critique was “ingenious” but “wrong” and that it was similar to … Read more

Black-Scholes: a navigational analogy

My previous post presumed some understanding not just of the Black-Scholes formula, but also of its derivation; in particular, of the hedging argument whereby the drift in the underlying asset can be ignored. My likely readers at this blog probably do understand this, but some other commentators may not. How to explain?  Here, with some trepidation, is … Read more

No-negative-equity guarantees: Black-Scholes and its discontents

The Prudential Regulation Authority (PRA) has issued a consultation paper CP13-18 on valuation of the no-negative-equity guarantee (NNEG) in equity release mortgages.  I think the use of the Black-Scholes formula in this context is flawed, in ways which are more fundamental than suggested by the PRA’s rather bland observation that “some of the assumptions that allow the mathematical … Read more

Why I am not a value investor

The header is a playful provocation: in truth I am probably closer to a value investor than any other type. But I place little credence on the historical superiority of value investing (which has faltered in recent years anyway), and I have little sense of affiliation or identity as a value investor.  It’s not quite that I don’t want to … Read more

On the limits of behavioural finance

Behavioural finance is a fashionable genre of academic research, and a productive strategy for writing academic papers.  But it was not mentioned as a resource by any of the interviewees in Free Capital, and I have never found it much help in my own investing.  There are several reasons for this.   Many explanations, few predictions The comprehensive menu of alleged behavioural … Read more