Daily Speculations The Web Site of Victor Niederhoffer & Laurel Kenner Dedicated to the scientific method, free markets, deflating ballyhoo, creating value, and laughter;  a forum for us to use our meager abilities to make the world of specinvestments a better place.

Home

Write to us at: (address is not clickable)

July 2003
Tom Ryan on Conflicting Signals

David A. Lagnado and David R. Shanks of the Department of Psychology, University College London, in find inspiration among the bookies for a most interesting paper, "The Influence of hierarchy on probability judgment."  The abstract: Consider the task of predicting which soccer team will win the next World Cup. The bookmakers may judge Brazil to be the team most likely to win, but also judge it most likely that a European rather than a Latin American team will win. This is an example of a non-aligned hierarchy structure: the most probable event at the subordinate level (Brazil wins) appears to be inconsistent with the most probable event at the superordinate level (a European team wins). In this paper we exploit such structures to investigate how people make predictions based on uncertain hierarchical knowledge. We distinguish between aligned and non-aligned environments, and conjecture that people assume alignment. Participants were exposed to a non-aligned training set in which the most probable superordinate category predicted one outcome, whereas the most probable subordinate category predicted a different outcome. In the test phase participants allowed their initial probability judgments about category membership to shift their final ratings of the probability of the outcome, even though all judgments were made on the basis of the same statistical data. In effect people were primed to focus on the most likely path in an inference tree, and neglect alternative paths. These results highlight the importance of the level at which statistical data are represented, and suggest that when faced with hierarchical inference problems people adopt a simplifying heuristic that assumes alignment.

When faced with two conflicting signals, represented by a superordinate signal and a subordinate signal, people tend to fall into one of two camps. People are biased and believe more in one set of data than another (macro vs. technical for example). They then tend to adopt one signal and assume that the other conflicting signal is not relevant or not accurate. Few try to take both signals and adopt them into a framework for decision-making. We all have this problem as traders too, don't we? Of course there is no "right" answer. And one of the primary characteristics of a complex adaptive system is that there is a hierarchy of signals.