Wednesday, January 19, 2005

Gut instinct, or efficient markets?

Slate is running an interesting dialog between Malcolm Gladwell and James Surowiekci, two of the New Yorker's best writers, and authors of the recent books Blink and The Wisdom of Crowds.

Blink is about instances when a snap judgement (relying on murky subconscious processes) may actually be superior to reasoned decision making. Surowiecki's book documents cases where the aggregate wisdom of many individuals is superior to that of a lone expert (the efficient market!). If the two notions seem hard to reconcile, join the club and read the dialog.

Surowiecki's thesis is one I've thought a lot about. In instances where the answer to a problem takes a fairly simple form ("What is the value of a share of Microsoft?" or "How many pennies are in this jar?"), it is plausible that the aggregation of all opinions eliminates biases in a useful way. While the market may be far from completely efficent, it is nevertheless hard to beat it consistently. (Don't try this with questions like "How do we reconcile quantum mechanics with general relativity?", though. In that case it might be better to ask the acknowledged expert than the crowd.)

On the other hand, I suspect that in many cases people's intuition is just plain bad, and systematic reasoning offers better results. (At least, that's my gut instinct ;-) For example, it is well documented from behavioral finance that people have a very bad innate understanding of probabilities and risk. This doesn't exclude the possibility that for certain questions, like "can I trust this guy with my girlfriend?", perhaps evolution has provided us with a lot of hard-wired machinery to quickly deduce the answer.

From David Brooks' review of Blink in the Times:
"Gladwell says we are thin-slicing all the time -- when we go on a date, meet a prospective employee, judge any situation. We take a small portion of a person or problem and extrapolate amazingly well about the whole. A psychologist named Nalini Ambady gave students three 10-second soundless videotapes of a teacher lecturing. Then she asked the students to rate the teacher. Their ratings matched the ratings from students who had taken the teacher's course for an entire semester. Then she cut the videotape back to two seconds and showed it to a new group. The ratings still matched those of the students who'd sat through the entire term."

Note added: the last election combined elements of Blinkish thin-slicing, as well as purported Wisdom of Crowds. It looks like the crowd trusted their gut instincts (rather than systematic reasoning?) and elected Bush. We'll see whether that was a better decision than an "expert" like me would have made ;-)


maxkennerly said...

I intuitively dislike David Brooks, though the crowd seems to trust him. My snap judgment was that he was the kind of person who just plain made things up to 'prove' his point, and that turned out to be correct:

The New Republic has a particularly unkind review of Blink by Richard Posner:

Though Posner's comments seem to mirror some of what I felt about Gladwell's The Tipping Point (notably his overreliance on anecdotal evidence), I am quite sure jealously over the dramatically larger sales Gladwell's Blink will enjoy over Posner's Catastrophe played a significant role in Posner's tone, as evidenced not least by the gratutious note about how Blink seems written for people who don't read books.

Since you follow forex, the question I'd ask you is: assuming forex prices are based on the market sense of 'fundamentals,' do you believe those 'fundamentals' the market compares to determine an exchange rate should be the relative strength of the two economies being compared or should follow more directly currency-related matters as price purchasing parity and relative interest rates? The former seems to dominate these days--but what if that doesn't make sense?

In other words, what happens when the entire crowd predicates their assumption on an erroneous belief? Do we get a bubble that the 'real' fundamentals eventually reveal, or do we simply change the nature of the commodity? The same analysis can be applied to "conventional wisdom," like the conventional wisdom that heavier cars are safer. Well, no, an SUV is not necessarily safer than a station wagon--in fact, it's probably less safe. But do you think the tendency of the crowd is to eventually figure that out, or to always wander in ignorance?

My gut tells me the latter happens more often than someone like Surowiekci would like to admit.

Anonymous said...

Thought provoking entry(as always!).

As you noted, I find it hard (actually, impossible) that aggregate of non-experts would be better than an expert in certain types of questions, say in pure mathematics or theoretical physics.

On the other hand, when the system is so probabilistic with so many variables with unknown impacts, the average is likely to better than an "expert".

But then, can one really say they are "experts", who I would define to be one who knows all the variables and their possible impacts on outcomes. Likely, there are no (and can never be, I think)"experts", by such a stringent definition is most fields, like social sciences.

I think what it means is that "a little knowledge is more dangerous than total ignorance" :)


Anonymous said...

When oil was 12 dollars a barrel and evidently approaching 10 in 1999, the market had decided that the price was right. Any price was and in right, for a time. Analysts were singing songs of oil below 10 dollars. There were those who sold oil at 12 and those who bought. Buying was of course proper. There is no right or wrong price of oil, only a continually changing price that makes buyers and sellers right and wrong depending on future prices. Guessing at future prices allows a heck of a lot more reasonably astute people to be right than guessing at the coming year's flu virus strains.


Anonymous said...

I found "The Wisdom of Crowds" quite unconvincing. Mostly because it was argued from way too much of an anecdotal perspective. Clearly there are situations were the crowd is good and times when the crowd is not good. The weakness of the book was in not spending enough time covering when the crowd is not good. And further, if the idea of using the crowd for wisdom is to have any merit, you need to be able to predict before hand when the crowd will be good and when it will be bad. How do you do this?

Dave Bacon

Anonymous said...

Having borrowed a copy of "Wisdom of Crowds," I realize freshly never ever pay attention to David Brooks. I gave way after 100 pages. There is no rigor in the argument, and limited charm to the anecdotes. This might make for a reasonable comic film, nothing more. there are times when crowds are right but times when wrong. Duh.


Anonymous said...

Does the size of a crowd matter :) ?


Anonymous said...

Hold That Thought: Haste Isn't All Waste

'The Power of Thinking Without Thinking'
By Malcolm Gladwell

Malcolm Gladwell, whose best seller ''The Tipping Point'' (2000) analyzed the means by which fads and ideas propagate, has written a similarly anecdotal account of how split-second decisions are made. In ''Blink,'' he finds scientists who break down the ostensibly simple processes of perception into quantifiable elements. He finds 90 different attributes ascribed to the Oreo cookie, and an extra $789 a year in salary for every extra inch of a tall person's height. He determines that people exposed to the words ''wrinkle,'' ''bingo'' and ''Florida'' can be made to feel old in a hurry.

Mr. Gladwell offers evidence that students can tell as much about a teacher in two seconds as they can in a semester. He finds a behavioral scientist who looks for 20 numbered elements -- whining is No. 11 -- in the way newlyweds discuss their smelly dog. He points out that surgeons who spend an average of three extra minutes talking to each patient are less likely than taciturn types to be sued for malpractice, regardless of what happens on the operating table. More intuitively, he knows ''why you can recognize Sally from the eighth grade 40 years later but have trouble picking out your bag on the airport luggage carousel.''

If the hypotheses of ''Blink'' are accurate, you may already have an opinion about whether Mr. Gladwell's second book interests you. Perhaps you also have a hunch about whether his thinking holds any surprises. Bear in mind that ''Blink'' takes a scientific approach to the following phenomena: that good-looking but incompetent politicians (like Warren G. Harding) can be elected to high office; that people think they favor one kind of mate but fall in love with another; that a mess in someone's bedroom exposes that person's hidden nature. In this context, the news that ''snap judgments are, first of all, enormously quick'' passes for a bright idea.


Anonymous said...

An alternate and more sound review.


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