Trying to Spot a Black Swan? Don’t Bother.

Why predictions are bunk.

September 20, 2010

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1134718_tarot_cardsInteresting perspective on our predilection for predictions by The Deal editor-in-chief, Robert Teitelman:

We live in a prediction society.

That’s another way of saying we live for the future, our minds restlessly casting forward to some concatenation of forces, energies and tendencies that will produce a certain effect at a specific time: a sunny day, high of 87, meteor shower at midnight or, better yet, Dow 36,000. Homo sapiens has undoubtedly always needed to peer ahead through the banana leaves to an uncertain future, if only to get that next meal. But our fixation on the future, our deep, often subconscious belief in progress, is an aspect of modernity, fueled by the acceleration of technological change, and the rise of growth-oriented economies driven by free markets. In a performance culture, the future always beckons. Our success in those areas, particularly in the ability of “hard” sciences like physics to accurately predict natural processes, has emboldened us. We are all forecasters now, nowhere more so than in finance. We look back only to peer forward; the past has become a warehouse of shrouded furniture awaiting new digs. We drill into historical prices in hopes of establishing a discernible pattern into the future. We poll the masses, or accumulate Internet data, to extract some sense of how they’ll react in the future. We ponder charts. We strain to master mechanisms — economic, market, governance, sentiment — in the belief that a known set of causes will create a known set of effects. We live for prediction because we need to believe in an orderly world where a known past shapes a predictable future. We’re free agents dreaming of determinism. Of course we fail regularly. Sometimes embarrassingly. Occasionally spectacularly. In hindsight, stupidly, foolishly, malevolently. How did we miss that expanding disaster at our feet? Prediction is famously like hitting a baseball. Infallibility is (as far as history has ever told us) impossible; the best prognosticators aim for a decent average. We (you, me, Alan Greenspan) always whiff at the wrong time.

It’s no surprise money managers that can beat the market over a decent period are rare — and deified. And it’s no shock success can be interpreted as luck. The task, as academics prove regularly, is daunting. Why? Well, there are fundamental tendencies of the prediction game that undermine the old Newtonian cause and effect. Complex systems are tougher to predict than simple systems. Long term is harder to forecast than short term; indeed, as you mentally extend yourself in time, predictions detach from fact and drift off like balloons into the speculative ether. The more people, as opposed to physical or natural forces, involved, the more capricious the future. Knowing a black swan exists is not the same as predicting its squawking arrival. Looting the bottomless past for similarities to current conditions is more fantasy than forecast. You’re always up against Nature’s dart tossers, formidable rivals. Full article here.

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