Strategy a Function of Skill

Monday, August 24th, 2009

The ideal strategy is a function of skill:

Simon Ramo identified the crucial difference between being a good at ‘amateur’ tennis, and professional tennis: for the best of the best, you need good ‘winning’ shots; to be a good ‘average’ player, you need to merely lower your failure rate. In expert tennis, 80% of the points are won, while in amateur tennis, 80% are lost.

Erik Falkenstein brings this notion into the world of investing:

I think this is relevant to investing, in that for retail investors, who don’t have an edge, they should prioritize the following: minimize costs and diversify. For that select few with an edge, the focus is on fundamentals (financial statements, business model), and though you minimize costs and diversify to the degree you can, it isn’t a priority.

Posted in Business, Eric Falkenstein, Games | No Comments »

Politicians are like drum majors

Sunday, August 23rd, 2009

Politicians are like drum majors, Eric Falkenstein says:

To many unaccustomed to what marching bands do, it seems they rule the roost. In fact, they merely are little garnishes, of what composers, and directors, and first chairs, have done. So too politicians, they are, and desire to be, inkblots, whatever you read into them as long as it’s positive.

Posted in Eric Falkenstein, Policy | No Comments »

Good Forecasts Will Strike Most People as Too Simple

Saturday, August 22nd, 2009

Good forecasts will strike most people as too simple, Eric Falkenstein notes — so put a little squiggle at the end:

The issue was put well in a test by Tversky and Edwards in 1966 (“Information versus reward in binary choices,” Journal of Experimental. Psychology 71, 680–683). Subjects were shown a succession of cards, each card either red or blue. 70% of the cards were blue, and 30% red; the color sequence was random. The subjects, asked to bet on each succeeding card, would guess blue around 70% of the time, and red about 30% of the time. They didn’t realize that their betting pattern did not have to resemble the observed sequence of cards. On each round, blue is the most likely next card. The best strategy is not betting a mostly-blue pattern resembling the mostly-blue sequence, but betting all blue.

Under conditions of uncertainty, your optimal forecast pattern doesn’t resemble a typical sequence, because optimally you should assume every random disturbance equals zero, when we know it will actually be merely distributed around zero.

Probabilistically, the more detail, the more unlikely; in practice, convincing scenarios have a lot of specificity, like a good novel. But novels are fiction, and the future is not. Thus, 4 variable Vector-Auto-Regressions outdo 400-equation macro models, and default models with 4 inputs out-do CFA worksheets that examine 50 different accounting ratios. This is obviously non-intuitive, not natural, as demonstrated by Tversky and Edwards, but also if you look at the standard tools to evaluate credit risk which give you so much information.

Thus, paradoxically, a good model should be a tougher sell than an overfit model. If the great unwashed (but white collar) masses like your ‘model’, you are probably going to fail if your goal is to predict well. A good model should cause unsophisticated people (i.e., most people) to think your model is insufficiently complex, because, intuitively, it is missing components X, Y and Z we see in actual data. But adding X, Y and Z merely increases the mean-squared error. Modeling ‘feature creep’ comes from giving people what they want, rather than what they need.

Posted in Economics, Eric Falkenstein, Science | No Comments »

The Insidiousness of Government Solutions

Friday, August 21st, 2009

The Atlantic‘s American Murder Mystery is about the demolition of Memphis’s public-housing projects, as part of a nationwide experiment to free the poor from the destructive effects of concentrated poverty:

Memphis demolished its first project in 1997. The city gave former residents federal “Section8” rent-subsidy vouchers and encouraged them to move out to new neighborhoods. Two more waves of demolition followed over the next nine years, dispersing tens of thousands of poor people into the wider metro community.

If police departments are usually stingy with their information, housing departments are even more so. Getting addresses of Section 8 holders is difficult, because the departments want to protect the residents’ privacy…. Janikowski merged his computer map of crime patterns with Betts’s map of Section8 rentals…. the match was near-perfect… She knew right away that this would be a “hard thing to say or write.” Nobody in the antipoverty community and nobody in city leadership was going to welcome the news that the noble experiment that they’d been engaged in for the past decade had been bringing the city down, in ways they’d never expected.

This leads Erik Falkenstein to discuss the insidiousness of government “solutions”:

The idea began with Lyndon Johnson’s Kaiser Commission on Urban Housing, which mistakenly believed that the private housing market created poverty, and the ills associated with it, by making housing too expensive. Thus, by reducing housing expenses via vouchers, and spreading the poor around the community, poverty, and the social ills associated with it, would fade away. That’s the theory. It turns out, the main problem of poor people is not a lack of money, but the temperance, diligence, thrift and other bourgeois virtues needed to be good citizens and neighbors. They bring their bad habits with them, statistically.

Given that it took 40 years to document this, this means that any big policy started today, will probably not be amenable to empirical analysis in my lifetime. Less than the 70 years of communism in the Soviet Union, but same scale. That’s the big risk to big top-down ideas.

But the insidiousness comes from the way the government, from federal down to city level, hid this data for decades because they didn’t want people to discriminate against section 8 areas or their residents. This means, if they put a high concentration of people with high criminality next to your house, they didn’t want you to know, based on the assumption that the poor’s behavior was either due to a lack of housing (which section 8 addresses directly), or the ‘stereotype effect’ from people who see them as poor. But the theory was wrong, and so all those millions of people had to deal with this problem themselves, and if they asked questions in local papers, they were labeled racist, or anti-poor.

Posted in Economics, Eric Falkenstein, Policy, Urbanism | No Comments »

Reverse Dominance Hierarchies

Thursday, August 20th, 2009

Why are our leaders so slightly above average? Because, Eric Falkenstein explains, humans prefer reverse dominance hierarchies:

The gist of his idea is that a love of dominance was so bred into the human species (males above all) during their long, shared hominid past, that they developed an innate distaste of being dominated by others. Thus armed with a motive, and using the cooperative skills which language and their big brains conferred upon them, all the lesser males in a group who were in danger of being dominated by an alpha male, would form a ‘reverse dominance hierarchy’ to put the would-be tyrant in his place. In this way, dominance behavior, while not eliminated entirely, could be moderated and dispersed.

As the anthropologist Harold Schneider puts it: ‘all men seek to rule, but if they cannot, they seek to be equal’. Upstarts are put in their place in a variety of ways. For example, !Kung bushmen will mock the gift of someone, because they see gift giving as an attempt to signal superior status. In effect, they ridicule this act because they see it as a pretext (clever bushmen!). In more complex societies, groups of men actually kill the upstart for a crime conveniently determined. Thus, egalitarianism is an implication of this aversion to strong rulers.

So much political punditry is a farce because all these policy wonks parse the words of politicians as if they were The Oracle at Delphi. Any real depth in these remarks is like reading one’s anxieties into inkblots. If you read the text of any politician, the main feature is its blandness, the smarmy, recycled clichés that allow listeners to believe it means whatever they want it to. The president of the US, like the president of your senior class, or the general secretary of the UN, is someone chosen for his malleability and his simultaneous ability to appear non-malleable, as if we want him to be smart sounding but not smart. It’s tolerable once you realize its comical.

At the margin there are differences, sometimes greater than others, but one must admit that the main attribute of such ‘leaders’ is being ingratiating and non-threatening to the greatest number of people. Humans do not wish to have ‘rulers’ with high intelligence or education, because these people would be less controllable.

I think we can all agree that this explains why we‘re not in charge.

Posted in Eric Falkenstein, Policy, Science | No Comments »

Taleb is a classic crank

Wednesday, August 19th, 2009

In Martin Gardner’s taxonomy, Eric Falkenstein explains, Nassim Nicholas Taleb is a classic crank:

  1. They have a profound intellectual superiority complex.
  2. They regard other researchers as idiotic, and always operate outside the peer review.
  3. They believe there is a campaign against their ideas, a campaign compared with the persecution of Galileo or Pasteur.
  4. They attack only the biggest theories and scientific figures.
  5. They attack only the biggest theories and scientific figures.

On his personal website, Taleb once described himself as being “an essayist, belletrist, literary-philosophical-mathematical flâneur,” a conception that some people finding endearing, me not so much. Literary-philosophical-mathematical types,- especially flâneurs – tend to be ‘full of themselves,’ supporting Gardner ’s characteristic #1. He prides himself on not submitting articles to refereed journals, considers most people who are indifferent to him as fools, and disdains editors, even spellcheckers (#2). He proudly notes that someone told him “in another time he would have been hanged [for what, inanity?].” Wilmott Magazine, a quant publication published by his colleague Paul Wilmott, wrote a fawning article about him in which they noted that he is “Wall Street’s principal dissident. Heretic! Calvin to finance’s Catholic Church” (#3). His website states his modest desire to understand chance from the viewpoint of “philosophy/epistemology, philosophy/ethics, mathematics, social science/finance, and cognitive science”, supporting #4. Lastly, for #5, he has gone so far as to print a glossary for his neologisms (eg, “epistemic arrogance” for “overconfidence”). In Martin Gardner’s taxonomy, Taleb is a classic crank.
[...]
Taleb is consistently amusing because his criticisms of others apply so neatly to himself: he claims he is an empiricist yet supports his points with anecdotes. The Black Swan makes fun of ‘experts’ with credentials, but he states he does not deign to engage with anyone not sufficiently expert; he states he is not interested in being a speaker-bureau commodity , but routinely travels the rubber chicken circuit; he derides forecasters who don’t give a full accounting of their prior forecasting history, yet delinks old remarks about Value-at-Risk, and recategorized his extinct Hedge Fund as a hedge, not a fund; he claims to prize humility, yet is most immodest; he argues against applying the law of large numbers, and also of inferring too much from small samples; people apply models to reality in biased manner, people naively extrapolate data without the appropriate theory; forward thinking is adaptive, forward thinking is error-laiden. Some people think inconsistency is a sign of genius; I think it just reflects confused thinking.

Read the whole thing. I skipped ahead to the punch-line. Falkenstein poked fun at Taleb earlier, too.

Posted in Economics, Eric Falkenstein, Nassim Nicholas Taleb | 2 Comments »

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