what exactly is this hazard rate thingie?
I was shocked to see that as well, but I think you can safely ignore it. It comes from survival probability (and is used in credit analysis.) If there is a probability of 0.95 that your customer will live one more year, and a probability of 0.90 that he will live two more years, then the “hazard rate” would be the “event rate” of death in some period, for example, -(0.90 - 0.95)/0.95 that he will die by year 2 conditional that he lives to year 1 … something like that. I don’t think we have to worry about it!
wow, DD, you are good!
I believe it has to do with the possibility that the investor will outlive his/her wealth. So based upon your retirement age,years until death, and spending rate, it gives you the probability that would outlive your wealth. e.g. if you are 65 years old and you want the probability that you would outlive your wealth to be less than 10%, you would arrive at the maximum spending rate (% of assets)/year where the this probability number is less than or equal to 10%.
Can someon refer me to this in the cfai text?
I wouldn’t worry at all about it, it’s in an exhibit p 232 vol 3, never used for anything and I checked the ebook curriculum, it’s never even mentioned again. I was trying to come up with a good explanation for it to answer your question, but I can’t really improve on BTON04’s explanation. but it’s not needed. if you look at the exhibit on p 232, if you are 65 and you want to establish a spending rate so that you have no more than a probability of 9% of ruin (outliving your assets) you’d spend at a rate of 4% or less. I think all the hazard rate means in this context is that GIVEN that you’ve lived to some point (say 65) there’s a hazard rate probability that you will die before the next time period, so a probability of 3.67% you’ll die before (66? 70? not sure.) Look at the endowment, time period is infinity and hazard rate is 0… 0 probability that if you make it to life of infinity years, you’ll die before the next time period. anyway I wouldn’t think another thought about it!