TITLE

Retirement Income Sustainability: How to Measure the Tail of a Black Swan

AUTHOR(S)
Milevsky, Moshe A.; Abaimova, Anna; Cavalieri, Brett
PUB. DATE
October 2009
SOURCE
Journal of Financial Planning;Oct2009, Vol. 22 Issue 10, p56
SOURCE TYPE
Academic Journal
DOC. TYPE
Article
ABSTRACT
•The last few years have been especially challenging for financial advisers, partially because of extreme stock market and interest rate movements.These events were unprecedented and outside conventional forecast ranges. •This paper describes a new methodology for measuring the overall risk embedded within a retirement income plan, motivated by the existence of "black swans," an idea introduced by Nassim Taleb in his best-selling book The Black Swan: The Impact of the Highly Improbable. •The SORDEX ratio, which is fully explained and illustrated within the article, is defined by the simple relationship A/B - 1, where A is retirement income sustainability given current conditions and B is retirement income sustainability under extreme conditions. The greater the value of this SORDEX ratio, the more vulnerable is the retirement income plan to a black swan. •The SORDEX ratio measures the extent to which the results of a conventional Monte Carlo simulation (MCS) and analytic probability representation (APR) values can change over time. •We suggest that, for the purposes of implementation and using this new measure, extreme conditions should be defined as events that are likely to occur less than 1 percent of the time, within a three-year time frame. •The sustainability numbers and hence the SORDEX ratio can be obtained using any commercially available MCS software or APR. •If a plan has a SORDEX ratio above 1, it should raise alarm bells, and a value greater than 2 indicates that your client's retirement is quite vulnerable to a black swan. Make sure to monitor this client (more) closely.
ACCESSION #
44677401

 

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