Overweening Generalist

Wednesday, July 13, 2011

Potshots at Economics: Take Four

Recall the previous potshots, then consider this (rather ironic?) quote from Nassim Nicholas Taleb:

"It is also naive empiricism to provide, in support of some argument, series of eloquent confirmatory quotes by dead authorities. By searching, you can always find someone who made a well-sounding statement that confirms your point of view - and, on every topic, it is possible to find another dead thinker who said the exact opposite." - footnote, p.xxvii of The Black Swan

I stand guilty of this, and the problem with it resides in you, Dear Reader, for you have to decide if the quotes and the "argument" (in my case, a sort of petulant series of claims consisting of admitted "potshots") have merit, or qualify as edifying discourse in some odd way...

What is this "Black Swan"? Taleb describes it as an extreme event, which we are/were blind to for various reasons. "The Black Swan is based on the structure of randomness in empirical reality." (xxvii, op.cit)

After a Black Swan occurs, "experts" give reasons why it happened, but if they know "now" why didn't they say something before? (A: Because their role is to try to convince you everything is under control, and they deserve the money and status they have for being "experts"?)

If you have not read this book, you might want to get hold of it, ASAP. To illustrate his point: some aspects of "reality" seem to be easily modeled by statistics, the Bell Curve, and by economists and others Taleb calls "nerds." But other aspects of "reality" that we think we can model and predict by Bell Curves and other Idealized notions of predictable regularity are things about which we are sadly, horribly mistaken. And yet, all kinds of "experts" don't know this. This is perhaps the main reason the August 2008 worldwide economic meltdown occurred.

Aspects of "reality" amenable to statistics and Bell Curves Taleb says belong to the land of "Mediocristan." Here's one way to think of it: take a thousand people from the world population at random and put them in a football stadium. Line them up, then add the heaviest person in the world to the sample. Does he weight 900? One of those guys who hasn't left his bed for nine years, and who will end up being buried in a piano case? A guy that Oprah tries to help out, right? He still doesn't make much of a dent in the overall weight of the sample of 1001 people. Human weight is subject to the laws of Mediocristan. You're not going to find a person who weighs 9000 pounds; it just isn't possible...but it looks like half of the state of Mississippi is trying.

Now take those same thousand people in the stadium - the poor 900 pound guy has left the building, probably on a fork lift - and add Bill Gates. Now, before Gates the average income of the group was X. But suddenly, with the addition of one dude, the average income has skyrocketed to some totally insane number. Sure, Gates makes up 99.999% of the total income, but the point is this: income is subject to the land of "Extremistan." The mathematics that describes Extremistan is Mandelbrotian randomness, after one of Taleb's intellectual heroes, the Father of Chaos Math, Benoit Mandelbrot. You've seen fractal art, right? Mandelbrotian stuff, that...

"Another way to rephrase the general distinction is as follows: Mediocristan is where we must endure the tyranny of the collective, the routine, the obvious, and the predicted; Extremistan is where we are subjected to the tyranny of the singular, the accidental, the unseen, and the unpredicted. As hard as you try, you will never lose a lot of weight in a single day; you need the collective effect of many days, weeks, even months. Likewise, if you work as a dentist, you will never get rich in a single day - but you can do very well over thirty years of motivated, diligent, disciplined, and regular attendance to teeth-drilling sessions. If you are subject to Extremistan speculation, however, you can gain or lose your fortune in a single minute." (p.35, op.cit)

Black Swans happen in Extremistan, and because of the complex way the world has grown lately, it is more and more dominated by Extremistan. We all live in Extremistan now, Taleb says, but most of us are totally unaware of it, because "Platonified" experts and pundits think in terms of Mediocristan. And because of Mediocristan being what it is, most of the time they're close enough to not lose their standing as "experts." But it's a different story with Economists...

Few Economists are in the mediasphere, so their epic failures are not noticed. Their very roles assume they have the data to project some statistics that will at least be shown to have been close. But it seems very few professional academics had any inkling August 2008 would happen. That's because their models contain vast hidden biases and assumptions that favor Mediocristan.
One of the most staggering things I learned from Taleb's book is that, very very VERY rarely does any smart-assed intellectual with good math skills do the research to compare what brokers or other experts predicted compared with how things actually turned out. And the book is filled with evidence and stories of money/finance/banking people who are such phonies you wouldn't believe it...but there's almost no one who is pointing this out! "Look: so-and-so at this brokerage firm - a guy who has made $40 million in the last three years - has been flat-out wrong on almost everything!"

Combine this knowledge with the idea that these same people buy off Congress, write laws that will favor themselves, then they crashed the worldwide market...and got bailed out and then refused to lend, instead awarding themselves BONUSES! And some people are all worked up that Casey Anthony (or whatever that Bad Mommy's name was) got off?

When someone dares to point out when Mr. Three Piece Suit on Wall Street was wrong - to his face - about some prediction, Taleb has him nailed with every variety of excuse he gives...and why most people seem to nod and accept it.

One basic idea I got from The Black Swan is that, if we are only speaking of the world financial system, there have been more and more elements built into it by "experts" who don't know what they're doing; they've fallen in love with their data, which happens to say what their bosses wanted it to say. Consequently, because of Internet, the world system is far more complex and intertwined than ever, and a basic level of fragility or brittleness has been built into the system; all we do realistically is try to weed out as much of the too-high-risk aspects in order to make the system a bit more robust. Beyond that, we simply do not know...Taleb admits he doesn't know. He doesn't pretend he knows more than he knows. Personally, that's my kind of intellectual.

I could go on and on about the ideas in Taleb's book, and quote from it. But look back at the beginning of this post, when I quoted Taleb on quoting to support one's own argument. To go on would be fruitless. I've long been a Discordian, and I can pull the wool over my own eyes as well as anyone else!
(Okay, that was a Church of the Subgenius line, but we're all one big Erisian family that must "stick apart," eh?)

I will leave you with a short video of Nassim, if only to so you can get the flavor of the guy:


Ellie K said...

I don't know why Taleb says that there are so few data-based studies to verify the accuracy of trading strategies/ investment approaches. There are plenty of them. However, there may not be much attention given to the unfavorable ones. I can believe that, very easily.

I also know, from first hand experience, that there is the worse sort of exaggeration, blind acceptance, herd think, and everything else you said, among traders. Taleb is correct there! Why does this happen? Is it mass psychosis? I don't have no idea. Salaries are rarely proportional to contributed value either. All of this has worsened in the past 15 years.

Wall Street was not everyone's first choice career in the 1950's or 1960's. Engineering, accounting, building contractors, that was as well paying or better than Wall Street! And perceived as more modern, exciting.

Taleb's points are reasonable, sensible. I just wish he weren't so critical of quantitative analysis, given that he is a statistician, MBA and finance PhD, and teaches finance now. Analytical methods have their place, in finance and even economics, but (as Taleb says) to a much smaller extent than many will acknowledge! Asymmetric information and technology accessible to the very few are more worrisome to me lately. Well, it is ALL worrisome to me lately!

Thanks for including the video, I'm planning to listen to it next.

michael said...

I'm going to sound naive, but I never understood why bankers were ever considered more than just posh clerks.

Nassim's stuff: precisely because there are studies that bolster his POV and they're ignored: his raison de 'etre.

It seems easy to say that the Herd mentality in finance and economics - and you're not saying this, I know - is the main reason why things get meaner and stupider. I also think DOGMA about "free markets" and fairly idiotic but widely-believed "rational choice" were the models and assumptions most in the trade were brought up on. I also think they're not all that bright: hey, they're getting paid well, they've heard some stuff about their basic model being very very wrong in many ways, but then, Someone Else will take care of it...it's not MY job! (Well, that does sound Herd-ish, now, doesn't it?)

The SNAFU Principle may be at play too? In a rigid hierarchy, those below do not want to do or say anything those above them don't wan't to hear or see done. And they the same dynamic works all the way from the bottom to the top of the hierarchy. Who knows what led Obama to crack down on medical pot? It seems utterly stupid, but maybe he's getting really warped information, filtering from the bottom?

Back to Taleb: he accepts Platonified Bell Curve data, if that data is suited to being Platonified. If the data being represented is actually subject to Extremistan and is treated as if it's part of Mediocristan, he gets wonderfully snarky.

I am very much with you in worrying about runaway asymmetric info and tech accessibility.

Thanks for stopping in. Classes up the joint!