Update: 3 Apr 2009: I have been getting more positive about the possibility of a cyclical upturn before 2009 is over (what I like to call a fake recovery). Meanwhile, the punderati are seeing black when they should be seeing shades of grey. As a result, I wanted to re-post this December article as a reminder to all of you and to myself of the perils of becoming wedded to a certain ideological bias.
Also see the following article on the site Overcoming Bias.
Here’s the original post:
For a long time Byron Wien of Morgan Stanley used to have his “Ten Surprises for” whatever year we were about to enter. The predictions were sometimes head-scratchers and they were definitely ‘out there.’ Most of the time, these predictions ended up being wrong. Now, Saxobank has taken over from Morgan Stanley in this department. Their list is outlandish — and I’ll get to it in a moment. But, first, I want to say these predictions serve a very useful purpose.
It’s called thinking outside the box. All of us have a bias that reinforces a false belief in the certainty of what we believe to be true. It’s called the overconfidence effect. Basically, we construct a mental map in our minds of what is probable and what is improbable. Over time, these beliefs harden and become what is certain and what is certainly not. I got a true test of this in business school.
My professor asked us some off the wall question like how much does the earth weigh. After we wrestled with the question and wrote down our answers, he then asked us to put a 95% confidence interval around the answer. He said give me a range of numbers that you believe the earth’s weight is 95% certain to be in. We mulled this over and answered. Result? Our 95% confidence interval was wrong something like 40% of the time within the class. Why?
Basically, by asking us the first question: how much does the earth weigh and giving us a chance to think about it, our professor was secretly giving our little pea brains a chance to become overconfident. By the time he asked us the second question, we had become anchored to the first answer. Essentially, he asked us to think outside the box and the mix of our overconfidence and anchoring caused us to make catastrophically wrong answers.
That’s how humans work. And this was a 10-minute exercise. Just think if you spend your life looking at economic events and making predictions. The likelihood of your being anchored to a specific prediction is that much greater. Eventually, you become so overconfident about this prediction that you are willing to bet the farm on the outcome.
Enter Saxobank. They have just released a list of outrageous predictions like $25 oil and civil unrest in Iran. Now, even I had become anchored to $147 oil because I thought I was being aggressive in July when I predicted $100 oil (my secret whisper number was $70). So saying $25 a barrel is extreme to the max.
The point is we all need to make ourselves familiar with extreme outcomes. Otherwise, we risk becoming too certain about a range of possibilities that is much too narrow. And when the unexpected happens, we will be quite unprepared.
Source
[Outlook 2009] 10 outrageous claims from Saxobank – FT Alphaville
Outrageous predictions -Saxobank (pdf)
Related articles
Anchoring – Wikipedia
Overconfidence effect – Wikipedia
Originally posted on 18 Dec 2008 (1438 ET)