Discussion of Auditor's Loss Functions Implicit in Consumption-Investment Models

Abstract

I feel that Scott's paper is addressing a different type of problem than those presented previously at this conference. Others have been concerned with I consider technology issues, that is, how can auditor make better use of his resources? How can he bear less risk at same cost or bear same risk at a lower cost? But in all cases, auditor's loss function was taken as given, either explicitly or implicitly. Scott is addressing issue of what should this loss function be? In order to answer this question, we must consider role of auditor in society, his relationships with other actors in society, and technology is available to him. Scott suggests that we look at opportunity losses of a typical user due to auditor's errors, with hope that this loss function could be tied to a Bayesian approach to auditor's decisions. Of course, two researchers will seldom agree on exactly model is most appropriate, so I will not dwell on those model details that I could readily change if I were to try to implement model. Instead, I will point out three difficulties in Scott's approach that severely limit insights that I obtain from his analysis. Two difficulties have to do with model construction, third with approach in general. The first model construction problem arises because Scott includes only one risky asset. As pointed out in paper, the proportion of risky investment, kt, is very sensitive to specification of risky return, z, with result that loss function itself is also very sensitive. It would appear to me that proportion of wealth invested in an individual risky asset, and therefore loss function itself, would also be very sensitive to opportunities for user to diversify his portfolio. In fact, if we add a