Foxes, Hedgehogs, Forecasters
Niranjan Rajadhyaksha -
Wednesday, February 25, 2009 6:20 PM
How much do stock market analysts and economists really know about the future?
Not as much as some of them claim --- or claimed till recently.
A professor of organizational behaviour offers us some simple rules to understand which economic and stock market forecasters to trust and distrust.
Philip Tetlock borrows a concept made popular by the philosopher Isaiah Berlin, who noted in an essay that the fox knows many things but the hedgehog knows only one big thing. Tetlock warns against putting too much trust in number-crunching hedgehogs.
"The better forecasters were like Berlin's foxes: self-critical, eclectic thinkers who were willing to update their beliefs when faced with contrary evidence, were doubtful of grand schemes and were rather modest about their predictive ability. The less successful forecasters were like hedgehogs: They tended to have one big, beautiful idea that they loved to stretch, sometimes to the breaking point. They tended to be articulate and very persuasive as to why their idea explained everything. The media often love hedgehogs," says Tetlock in this interview with CNN Money.
A lot depends on the language that is used.
"Count how often they press the brakes on trains of thought. Foxes often qualify their arguments with "however" and "perhaps," while hedgehogs build up momentum with "moreover" and "all the more so." Foxes are not as entertaining as hedgehogs. But enduring a little tedium is worth it if you want realistic odds on possible futures."
And...
"If you want good, stable long-term performance, you're better off with the fox. If you're up for a real roller-coaster ride, which might make you fabulously wealthy or leave you broke, go hedgehog."
Meanwhile, David Brooks resurrects another philosopher in this oped in the New York Times to hit at a different target.
"When I was a freshman in college, I was assigned “Reflections on the Revolution in France” by Edmund Burke. I loathed the book. Burke argued that each individual’s private stock of reason is small and that political decisions should be guided by the accumulated wisdom of the ages. Change is necessary, Burke continued, but it should be gradual, not disruptive. For a young democratic socialist, hoping to help begin the world anew, this seemed like a reactionary retreat into passivity.
Over the years, I have come to see that Burke had a point. The political history of the 20th century is the history of social-engineering projects executed by well-intentioned people that began well and ended badly. There were big errors like communism, but also lesser ones, like a Vietnam War designed by the best and the brightest, urban renewal efforts that decimated neighborhoods, welfare policies that had the unintended effect of weakening families and development programs that left a string of white elephant projects across the world.
These experiences drove me toward the crooked timber school of public philosophy: Michael Oakeshott, Isaiah Berlin, Edward Banfield, Reinhold Niebuhr, Friedrich Hayek, Clinton Rossiter and George Orwell. These writers — some left, some right — had a sense of epistemological modesty. They knew how little we can know. They understood that we are strangers to ourselves and society is an immeasurably complex organism. They tended to be skeptical of technocratic, rationalist planning and suspicious of schemes to reorganize society from the top down."
I have read these gentlemen for too long to have an overly optimistic view of the ability of individuals to see and manage the future. So it felt good to stumble across a new paper by Douglas W. Diamond and Raghuram Rajan. (Disclosure: I have not yet read it.)
The title is suitably modest: The Credit Crisis: Conjectures About Causes And Remedies.
This is what the abstract says: "What caused the financial crisis that is sweeping across the world? What keeps asset prices and lending depressed? What can be done to remedy matters? While it is too early to arrive at definite answers to these questions, it is certainly time to offer informed conjectures, and these are the focus of this paper."
It reminds me of another philosopher, Karl Popper. One of his great books was titled Conjectures And Refutations.
Popper was always sceptical of certitudes. This is what he said in his book: "One of the oldest dreams of mankind—the dream of prophecy, the idea that we can know what the future has in store for us, and that we can profit from such knowledge by adjusting our policy to it."
Diamond and Rajan merely say that "it is too early to arrive at definite answers".
But hey, it's a start.