The Fallacy of Forecasting
"It's tough to make predictions, especially about the future."
Physicist Neils Bohr (1)
For all of human history man has longed to know the future. We Jews had our prophets, the ancient Greeks had their oracles, Renaissance people had their Nostradamus. Modern Man has astrology, Tarot cards and.......forecasters.
With modern astrophysics we can forecast astronomic events such as eclipses and appearances of known comets with exceptional accuracy decades in advance. Meteorologists have become adept at forecasting major weather events up to a week in advance.
But forecasting events in human history, such as wars, revolutions, and economic catastrophes is still no better than guesswork , according to a remarkable new book entitled "The Black Swan: The Impact of the Highly Improbable" by Nassim Nicholas Taleb. (2) The term "Black Swan" used in the book is a metaphor for an event (such as the 9/11 attacks) that is totally unexpected and has a major impact, either good or bad.
It is characteristic of the human mind to see events as part of a pattern, so that after a Black Swan event has occurred we try to fit it into a historical narrative that makes sense. According to Taleb, people strive to find a logical cause and pattern to even the most random incidences, which may explain the popularity of conspiracy theories (3). Evidence that confirms an accepted theory is welcomed, while equally valid evidence that points the other way is ignored.
Here are some myths blown away by The Black Swan:
1. The past is a good guide to the future.
In July of 1914 Europe had enjoyed over 40 years of peace, and many believed the age of war in the heartland of Europe was over. Within weeks, western Europe was the scene of the most destructive war in the history of the world at that time.
Remarks such as "The stock market goes up about 10% per year" and "Real estate prices always increase over time" indicate that the same tendency to extrapolate from the recent past holds sway today.
2. Experts can forecast economic trends.
In 1970 an official US government estimate, signed by the Secretaries of Interior, Treasury, State and Defense, predicted that the price of foreign oil in 1980 would not "experience a substantial increase." It went up tenfold!
On October 19, 1987, the Dow Jones Industrial Average dropped over 500 points. How many Wall Street analysts predicted that "Black Swan"? None-----all the charts and financial data they had failed to anticipate the historic plunge.
In January, 2006, The Wall Street Journal forecast that 2006 would be a bad year for stocks; the Dow went up 16% over the next 12 months.
Psychologist Philip Tetlock (4) asked 300 credentialed experts in economics and politics to judge the likelihood of a number of specific world events in the coming five years and to estimate the "error rate" of their predictions. The actual error rates were many times higher than the estimates; the predictions of the best-known experts were the worst of all! They thought they knew much more about the future than they really did.
3. The Theory of Games can be applied to the real world.
If you flip a coin 99 times and get heads each time, what is the probability of getting another head on the 100th trial?
Any mathematician will tell you that the probability of heads is 50%, since the coin has no memory. But a gambler will tell you that it is nearly 100%,, since a coin that did that is bound to be loaded to land heads-up. This is a paradigm of the difference between a theorist and a practitioner----- in the real world, believe the practitioner!
Unlike the world of mathematical games with their simple and fair rules, the real world is full of cheaters, liars, charlatans and the like. Just ask anyone who ever bought Enron stock!
According to Mr Taleb, the world is much more complicated and less predictable than we think it is. The main reason is that people, unlike planets and comets, have free will, so events dependent upon human actions can never really be determined in advance. This is a lesson we all can use!
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(1) Quoted in The Black Swan, p.136. According to the book, Yogi Berra often said this, but Bohr originated the saying.
(2) Random House, New York, 2006. The name of the publisher is too appropriate to be true!
(3) See the Feb.19, 2008, Glazerbeam on conspiracy theories.
(4) "Expert Political Judgment" by Philip E Tetlock, 2005.
Physicist Neils Bohr (1)
For all of human history man has longed to know the future. We Jews had our prophets, the ancient Greeks had their oracles, Renaissance people had their Nostradamus. Modern Man has astrology, Tarot cards and.......forecasters.
With modern astrophysics we can forecast astronomic events such as eclipses and appearances of known comets with exceptional accuracy decades in advance. Meteorologists have become adept at forecasting major weather events up to a week in advance.
But forecasting events in human history, such as wars, revolutions, and economic catastrophes is still no better than guesswork , according to a remarkable new book entitled "The Black Swan: The Impact of the Highly Improbable" by Nassim Nicholas Taleb. (2) The term "Black Swan" used in the book is a metaphor for an event (such as the 9/11 attacks) that is totally unexpected and has a major impact, either good or bad.
It is characteristic of the human mind to see events as part of a pattern, so that after a Black Swan event has occurred we try to fit it into a historical narrative that makes sense. According to Taleb, people strive to find a logical cause and pattern to even the most random incidences, which may explain the popularity of conspiracy theories (3). Evidence that confirms an accepted theory is welcomed, while equally valid evidence that points the other way is ignored.
Here are some myths blown away by The Black Swan:
1. The past is a good guide to the future.
In July of 1914 Europe had enjoyed over 40 years of peace, and many believed the age of war in the heartland of Europe was over. Within weeks, western Europe was the scene of the most destructive war in the history of the world at that time.
Remarks such as "The stock market goes up about 10% per year" and "Real estate prices always increase over time" indicate that the same tendency to extrapolate from the recent past holds sway today.
2. Experts can forecast economic trends.
In 1970 an official US government estimate, signed by the Secretaries of Interior, Treasury, State and Defense, predicted that the price of foreign oil in 1980 would not "experience a substantial increase." It went up tenfold!
On October 19, 1987, the Dow Jones Industrial Average dropped over 500 points. How many Wall Street analysts predicted that "Black Swan"? None-----all the charts and financial data they had failed to anticipate the historic plunge.
In January, 2006, The Wall Street Journal forecast that 2006 would be a bad year for stocks; the Dow went up 16% over the next 12 months.
Psychologist Philip Tetlock (4) asked 300 credentialed experts in economics and politics to judge the likelihood of a number of specific world events in the coming five years and to estimate the "error rate" of their predictions. The actual error rates were many times higher than the estimates; the predictions of the best-known experts were the worst of all! They thought they knew much more about the future than they really did.
3. The Theory of Games can be applied to the real world.
If you flip a coin 99 times and get heads each time, what is the probability of getting another head on the 100th trial?
Any mathematician will tell you that the probability of heads is 50%, since the coin has no memory. But a gambler will tell you that it is nearly 100%,, since a coin that did that is bound to be loaded to land heads-up. This is a paradigm of the difference between a theorist and a practitioner----- in the real world, believe the practitioner!
Unlike the world of mathematical games with their simple and fair rules, the real world is full of cheaters, liars, charlatans and the like. Just ask anyone who ever bought Enron stock!
According to Mr Taleb, the world is much more complicated and less predictable than we think it is. The main reason is that people, unlike planets and comets, have free will, so events dependent upon human actions can never really be determined in advance. This is a lesson we all can use!
--------------------------------------------------------------------------
(1) Quoted in The Black Swan, p.136. According to the book, Yogi Berra often said this, but Bohr originated the saying.
(2) Random House, New York, 2006. The name of the publisher is too appropriate to be true!
(3) See the Feb.19, 2008, Glazerbeam on conspiracy theories.
(4) "Expert Political Judgment" by Philip E Tetlock, 2005.
Labels: Black Swan, prediction, probability
posted by Gerald S Glazer at 10:17 AM
5 Comments:
Yes, indeed and people should think of this when considering the global warming debate. Almost nothing has yet happened that the global warming chicken littles are harping about and most of their "predictions"; are based on the very same type of mathematical anlyses (mathematical models, e.g. Monte Carlo simulations) that the economists use to predict where the economy is going.
While there may not be Enron's or Boesky's or other cheaters and liars in the field of environmentalism, the field is filled with self centered exaggerationists who make money off of "global warming" just as Ken Lay made money off of Enron.
Al Gore has made a career of presenting exaggerated and in many cases false claims regarding global warming and he has been rewarded for it in the millions of dollars.
The scientists who fuel this frenzy are not non-biased observers but people whose career and jobs depend on their getting government grants to study global warming. There is no doubt that the more dangerous and ominous the scientists make global warming to be, the more money they get and the easier it is for them to get the money and thereby keep their jobs in academia. The government is much more likely give scientists money to study issues when their is a problem to solve and the bigger the problem the more the money they can get.
Proof of this is that the very samne scientists who are crying global warming today were crying global cooling (the next ice age is around the corner) 25 years ago, e.g. Dr. Paul Ehrlich.
Yes, we all should read this book so we all understand Bohr's remark. Thank you for this excellent post.
Mr. Glazer,
I am a huge fan of Taleb's writing, wit, and keen perception. As an armchair investor, I can tell you that his prior work," FOOLED BY RANDOMNESS", forever changed the way I operate. If you enjoyed "Black Swan", then FBR is a must read.
You recognize, people unceasingly make comments when anything is predicted to take place in 2012, like “fairly that is if the world is still here.” You do realize that the Mayans predict the creation will end on Dec. 21 (or 23rd)? So in all good chance if anything is booming to happen in 2012 there is solitary the slimmest conceivability that the everybody hand down contain ended first it happens.
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