Integration-Difference – Part 2
From Taleb, Nassim Nicholas “Fooled by Randomness: The Hidden Role of Chance in Life and in the Market”
Economists were not at the time very interested in hearing these stories of irrationality:
Homo Economicus as we said is a normative concept. While they could easily buy the “Simon” argument that we are not perfectly rational and that life implies approximations, particularly when the stakes are not large enough, they were not willing to accept that people were
FLAWED/RATHER THAN IMPERFECT
Consider that your brain reacts differently to the same situation depending on which chapter you open to. The absence of a central processing system makes us engage in decisions that can be in conflict with each other.
“-All Decisions are of Overlapping, non-simultaneous Circumstance-Event-Happenings+” From JDS
You may prefer apples to oranges, oranges to pears, but pears to apples— it depends on how the choices are presented to you. The fact that your mind cannot retain and use everything you know at once is the cause of such biases. One central aspect of a heuristic is that it is blind to reasoning.
Bias)— the fact that the counter is reset at zero and you start a new day or month from scratch, whether it is your accountant who does it or your own mind. This is the most significant distortion and the one that carries the most consequences. In order to be able to put things in general context, you do not have everything you know in your mind at all times, so you retrieve the knowledge that you require at any given time in a piecemeal fashion, which puts these retrieved knowledge chunks in their local context. This means that you have an arbitrary reference point and react to differences from that point, forgetting that you are only looking at the differences from that particular perspective of the local context, not the absolutes.
JDS: This means to me that I’m looking from my choices and Limit my Experiences to make Decisions always from
“My Awareness/Presences first”.
All Decisions I Make Start with ME and “-My Awareness/Presences First+”
What do you look at: your monthly, your daily, your life-to-date, or your hourly performance?
You can have a good month and a bad day.
Which period should dominate?
In our life, what do we anchor our thoughts and decision-making to? JDS
Now, when something is in relation to something else, that something else can be manipulated. Psychologists call this effect of comparing to a given reference anchoring. If we take it to its logical limit we would realize that, because of this resetting, wealth itself does not really make one happy (above, of course, some subsistence level); but positive changes in wealth may, especially if they come as “steady” increases.
Other aspects of anchoring.
Given that you may use two different anchors in the same situation, the way you act depends on so little. When people are asked to estimate a number, they will position it with respect to a number they have in mind or one they just heard, so “big” or “small” will be comparative.
Kahneman and Tversky asked subjects to estimate the proportion of African countries in the United Nations after making them consciously pull a random number between 0 and 100 (they knew it was a random number). People guessed in relation to that number, which they used as anchor: Those who randomized a high number guessed higher than those who randomized a low one.
This morning I did my bit of anecdotal empiricism and asked the hotel concierge how long it takes to go to the airport. “40 minutes?” I asked. “About 35,” he answered. Then I asked the lady at the reception if the journey was 20 minutes. “No, about 25,” she answered. I timed the trip: 31 minutes. This anchoring to a number is the reason people do not react to their total accumulated wealth, but to differences of wealth from whatever number they are currently anchored to.
Two Systems of Reasoning
There are two possible ways for us to reason, the heuristics being part of one— rationality being part of the other.
System 1 is effortless, automatic, associative, rapid, parallel process, opaque (i.e., we are not aware of using it), emotional, concrete, specific, social, and personalized.
System 2 is effortful, controlled, deductive, slow, serial, self-aware, neutral, abstract, sets, asocial, and depersonalized.
I have always believed that professional option traders and market makers by dint of practicing their probabilistic game build an innate probabilistic machine that is far more developed than the rest of the population— even that of probabilists.
I found a confirmation of that as researchers in the heuristics and biases tradition believe that System 1 can be impacted by experience and integrate elements from System 2.
For instance, when you learn to play chess, you use System 2. After a while things become intuitive and you are able to gauge the relative strength of an opponent by glancing at the board.
Next I introduce the evolutionary psychology point of view.
WHY WE DON’T MARRY THE FIRST DATE
Another branch of research, called evolutionary psychology, developed a completely different approach to the same problem.
These evolutionary psychologists agree with the Kahneman-Tversky school that people have difficulties with standard probabilistic reasoning.
However, they believe that the reason lies in the way things are presented to us in the current environment. To them, we are optimized for a set of probabilistic reasoning, but in a different environment than the one prevailing today.
The statement “Our brains are made for fitness not for truth” by the scientific intellectual Steven Pinker, the public spokesmen of that school, summarizes it all.
They agree that our brains are not made for understanding things but think that they are not biased, or only biased because we do not use them in their real habitat.
(1) We do not think when making choices but use heuristics;
2) We make serious probabilistic mistakes in today’s world— whatever the true reason.
Note that the split even covers the new economics: Just as we have a scientific branch of economics coming out of the Kahneman and Tversky tradition (behavioural economics), there is another scientific branch of economics coming out of evolutionary psychology. From Taleb, Nassim Nicholas (2008-10-06). “Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets”
Creating a New Future by Design
Monitor Omni Feedback Loops.
1. Heuristics is learning from a set of Experiences and could create mental shortcuts that allows HU-Beings to Solve Problems and make Judgments Quickly. By Creating Feedback Loops of Risk, Heuristics play’s an important role of Problem Solving, Decision-Making, and Risk Mitigation.
2. Feed Loops always have Risk and Probabilistic Outcomes. This is an important thought…. there is always risk in the life of anything. It drive me to despair when I hear: “Write a plan“ or “Provide a Budget” or both. I think that both have extreme limitations. My despair is the difference between Predicting and Predictive.
· Predicting finds its sources from information and experiences from the Past. In Creating Futures, my fundamental belief is “-My Past Doesn’t have to Predict My Future+”. More importantly, I can’t Predict a Future. Yet banks, governments and HU-Beings hang their hats on Plans and Budgets, only to find terrible results from Predicting. It is just errant no-sense that 99% of SME’s fail. What fails 99% of the time is a HU-Being’s ability to Predict Futures as the norm. I really don’t know what % can predict.
What I do know……… Predicting anything is a Venture “-IN+” Luck
On another Thought, “-Probabilities of Change+” are Predictive
· Predictive considers the Past and the Immediate Vital Now, thinking through a Scenario of Problems/Opportunities and then Monitoring Feedback Loops of agreed Circumstances-Events-Happenings, always looking to Create an EMEL Future.
Cause-Conversion-Effect-Arranged Futures = Created Futures by Design
Predictive Considerations of Circumstances-Events-Happenings
“-Past-Present Vital Now-Created Futures+”
Without Fail, Changes will Happen with Any level of Motion, Physical or Metaphysical.
I think that is the total level of Predicting with any Accuracy. After that, it is Omni- Predictive, with each HU-Being being at Risk of their result.
I have, for the last 20 years, been exploring the idea that “Games are a Reflection of Behaviour”. (Yes…. I’m very slow at understanding concepts). It seemed to make sense to “ME” 20 years ago. In the last 7 years, I have been measuring the idea about Games, Reflections and of my Behaviour, only to find that the concept doesn’t fit within my measurements. Today is now a distress for ME. That is great news in my thinking. I have a small understanding of a new concept, with all my experiences, by being in motion and staying Naive and daring to question what I know (R.B.F. thought process).
Today, I would say “Games are a Reflection of Emotional Behaviour in a Circumstance (Environment/Context)”. I have a level of certainty…. an application of the Emotions Behaviour goes beyond the Reflection and now must have Refraction to a create pattern of Predictive Outcomes By Decisions made in a
Vital Now!-!
Decision-Making IN the 21 First Century:
1. Predictive Future Arrangements 2. Short to Medium Term Outcomes 3. Vital Actions Now
4: Feedback Loops
Satisficing
For a long time we had the wrong product specifications when we thought of ourselves.
We humans have been under the belief that we were endowed with a beautiful machine for thinking and understanding things.
However, among the factory specifications for us is the lack of awareness of the true factory specifications (why complicate things?).
The problem with thinking is that it causes you to Develop Illusions. And thinking may be such a waste of energy! Who needs it!
Consider that you are standing in front of a government clerk in a heavily socialist country where being a bureaucrat is held to be what respectable people do for a living. You are there to get your papers stamped by him so you can export some of their lovely chocolate candies to the New Jersey area, where you think the local population would have a great taste for them.
What do you think his function is?
Do you think for a minute that he cares about the general economic theory behind the transaction?
His job is just to verify that you have the twelve or so signatures from the right departments, true/ false; then stamp your papers and let you go.
General considerations of economic growth or balance of trade are none of his interests. In fact you are lucky that he doesn’t spend any time meditating about these things: Consider how long the procedure would take if he had to solve balance of trade equations.
He just has a rulebook and, over a career spanning forty to forty-five years, he will just stamp documents, be mildly rude, and go home to drink non-pasteurized beer and watch soccer games. If you gave him Paul Krugman’s book on international economics he would either sell it in the black market or give it to his nephew.
Accordingly, rules have their value. We just follow them not because they are the best but because they are useful and they save time and effort.
Consider that those who started theorizing upon seeing a tiger on whether the tiger was of this or that taxonomic variety, and the degree of danger it represented, ended up being eaten by it.
Others who just ran away at the smallest presumption and were not slowed down by the smallest amount of thinking ended up either out chasing the tiger or out chasing their cousin who ended up being eaten by it.
Satisficing It is a fact that our brains would not be able to operate without such shortcuts. The first thinker who figured it out was Herbert Simon, an interesting fellow in intellectual history. He started out as a political scientist (but he was a formal thinker, not the literary variety of political scientists who write about Afghanistan in Foreign Affairs); he was an artificial-intelligence pioneer, taught computer science and psychology, did research in cognitive science, philosophy, and applied mathematics, and received the Bank of Sweden Prize for Economics in honour of Alfred Nobel.
His idea is that if we were to optimize at every step in life, then it would cost us an infinite amount of time and energy.
Accordingly, there has to be in us an approximation process that stops somewhere.
Clearly he got his intuitions from computer science— he spent his entire career at Carnegie-Mellon University in Pittsburgh, which has a reputation as a computer science center.
“Satisficing” was his idea (the melding together of satisfy and suffice):
You stop when you get a near-satisfactory solution.
Otherwise it may take you an eternity to reach the smallest conclusion or perform the smallest act.
We are therefore rational, but in a limited way: “Boundedly Rational.” He believed that our brains were a large optimizing machine that had built-in rules to stop somewhere. 5-7 Plus or Minus 2 WD?
Not quite so, perhaps. It may not be just a rough approximation.
For two (initially) Israeli researchers on human nature, how we behave seemed to be a completely different process from the optimizing machine presented by Simon.
The two sat down introspecting in Jerusalem looking at aspects of their own thinking, compared it to rational models, and noticed Qualitative Differences. Whenever they both seemed to make the same mistake of reasoning they ran empirical tests on subjects, mostly students, and discovered very surprising results on the relation between Thinking And Rationality.
It is to their discovery that we turn next. FLAWED, NOT JUST IMPERFECT . From Kahneman and Tversky
Who have exerted the most influence on economic thinking over the past two centuries?
No, it is not John Maynard Keynes, not Alfred Marshall, not Paul Samuelson, and certainly not Milton Friedman.
The answer is two non-economists: Daniel Kahneman and Amos Tversky, the two Israeli introspects, and their specialty was to uncover areas where human beings are not endowed with rational probabilistic thinking and optimal behaviour under uncertainty.
Strangely, economists studied uncertainty for a long time and did not figure out much— if anything, they thought they knew something and were fooled by it.
Aside from some penetrating minds like Keynes, Knight, and Shackle, economists did not even figure out that they had no clue about uncertainty— the discussions on risk by their idols show that they did not know how much they did not know.
Psychologists, on the other hand, looked at the problem and came out with solid results.
Note that, unlike economists, they conducted experiments, true controlled experiments of a repeatable nature that can be done in Ulan Bator, Mongolia, tomorrow if necessary. Conventional economists do not have this luxury as they observe the past and make lengthy and mathematical comments, then bicker with each other about them.
Kahneman and Tversky went in a completely different direction than Simon and started figuring out rules in humans that did not make them rational— but things went beyond the shortcut.
For them, these rules, which are called HEURISTICS (a method of solving a problem for which no formula exists, based on informal methods or experience, and employing a form of trial and error iteration), were not merely a simplification of rational models, but were different in methodology and category. They called them “quick and dirty” HEURISTICS.
There is a dirty part: These shortcuts came with side effects, these effects being the biases, most of which I discussed previously throughout the text (such as the inability to accept anything abstract as risk).
This started an empirical research tradition called the “HEURISTICS AND BIASES” tradition that attempted to catalogue them— it is impressive because of its empiricism and the experimental aspect of the methods used.
Since the Kahneman and Tversky results, an entire discipline called Behavioural Finance and economics has flourished.
It is in open contradiction with the orthodox so-called neoclassical economics taught in business schools and economics departments under the normative names of efficient markets, rational expectations, and other such concepts.
It is worth stopping, at this juncture, and discussing the distinction between Normative And Positive sciences.
A Normative Science- negative (clearly a self-contradictory concept) offers prescriptive teachings; it studies how things should be. Some economists, for example those of the efficient-market religion, believe that our studies should be based on the hypothesis that humans are rational and act rationally because it is the best thing for them to do (it is mathematically “optimal”).
The opposite is a Positive Science+, which is based on how people actually are observed to behave. In spite of economists’ envy of physicists, physics is an inherently positive science while economics, particularly Microeconomics and Financial Economics, is predominantly a Normative One.
Normative Economics-Negative is like religion without the aesthetics. Note that the experimental aspect of the research implies that Daniel Kahneman and the experimental ponytailed economist Vernon Smith were the first true scientists ever to bow in front of the Swedish king for the economics prize, something that should give credibility to the Nobel academy, particularly if, like many, one takes Daniel Kahneman far more seriously than a collection of serious-looking (and very human, hence fallible) Swedes.
There is another hint of the scientific firmness of this research: It is extremely readable for someone outside of psychology, unlike papers in conventional economics and finance that even people in the field has difficulty reading (as the discussions are jargon-laden and heavily mathematical to give the illusion of science).
A motivated reader can get concentrated in four volumes the collection of the major HEURISTICS and Biases Papers. Economists were not at the time very interested in hearing these stories of irrationality: Homo Economicus as we said is a normative concept. While they could easily buy the “Simon” argument that we are not perfectly rational and that life implies approximations, particularly when the stakes are not large enough, they were not willing to accept that people were Flawed Rather Than Imperfect. But they are.
Kahneman and Tversky showed that these biases do not disappear when there are incentives, which means that they are not necessarily cost saving. They were a different form of reasoning, and one where the probabilistic reasoning was weak. From Taleb, Nassim Nicholas (2008-10-06). “Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets”.
Until next week
JDS OUT
