I think my original point was just that the effect (survivorship bias at the country level) exists and most people happily ignore it. Looks like we agree about that.
My follow-up point was that this effect—survivorship bias at the country level—belongs to the class of things which makes your estimates of future returns suspect. However we’ve moved on to another issue—how to account for the possibility of a major disaster (war, revolution, hyperinflation, etc.) while planning your life and what does this possibility and its consequences look like.
I think I’d like to stress the the consequences will be complicated and widespread, not reducible to lopping a percentage point off your expected returns. I also think that estimates have to be country-specific. The probabilities of the US going down are noticeably less than the probabilities of, say, Russia, going down. However a Russian implosion will be more contained (in the sense of affecting other countries) while if the US implodes it might well take the entire North America and Western Europe down with it.
One additional point is that you’re not only interested in the expected return on your portfolio. You are also interested in the expected variance. The probability of disaster does not only reduce your expected return, but it also pushes up, considerably, your expected variance as well as makes your expected probability distribution asymmetric (more asymmetric, really).
By the way, I do not agree that “the historical performance of an index like the S&P or Nikkei has the cross-country effects of disasters elsewhere already factored in.” The reason is that the interdependency of countries is not a constant. It grew a LOT during the XX century, especially its last few decades. For example, S&P is much more correlated with Nikkei now than it was in the 60s. Chinese economic numbers whipsaw Brazil (which exports huge amounts of iron ore to China) and significantly affect the US stock market. Or, remember what happened to the US stock markets when it turned out that Greece is bankrupt?
The world is much more interrelated now than it used to be. Historical performance does not reflect the current reality.
I think my original point was just that the effect (survivorship bias at the country level) exists and most people happily ignore it. Looks like we agree about that.
My follow-up point was that this effect—survivorship bias at the country level—belongs to the class of things which makes your estimates of future returns suspect. However we’ve moved on to another issue—how to account for the possibility of a major disaster (war, revolution, hyperinflation, etc.) while planning your life and what does this possibility and its consequences look like.
I think I’d like to stress the the consequences will be complicated and widespread, not reducible to lopping a percentage point off your expected returns. I also think that estimates have to be country-specific. The probabilities of the US going down are noticeably less than the probabilities of, say, Russia, going down. However a Russian implosion will be more contained (in the sense of affecting other countries) while if the US implodes it might well take the entire North America and Western Europe down with it.
One additional point is that you’re not only interested in the expected return on your portfolio. You are also interested in the expected variance. The probability of disaster does not only reduce your expected return, but it also pushes up, considerably, your expected variance as well as makes your expected probability distribution asymmetric (more asymmetric, really).
By the way, I do not agree that “the historical performance of an index like the S&P or Nikkei has the cross-country effects of disasters elsewhere already factored in.” The reason is that the interdependency of countries is not a constant. It grew a LOT during the XX century, especially its last few decades. For example, S&P is much more correlated with Nikkei now than it was in the 60s. Chinese economic numbers whipsaw Brazil (which exports huge amounts of iron ore to China) and significantly affect the US stock market. Or, remember what happened to the US stock markets when it turned out that Greece is bankrupt?
The world is much more interrelated now than it used to be. Historical performance does not reflect the current reality.