An item posted on his blog Marginal Revolution by FoC Tyler Cowen reminded me of Robert Bacon's notion of "ever changing cycles" as people jockey for advantage, acting independently on common perishable information:

"The collective optimization of individual driving routes by drivers using realtime traffic maps slows everyone down. That is, everyone picking the "fastest" route on the map results in overall slowdowns (…)".

Scott Brooks sees a religious angle:

That's one of the reasons why the saying, "everything works until it doesn't" is true. People find something good and then they tell everyone about it – and then it's ruined. We all tend to want to brag about our "find", when in reality, that is the worst thing we can do.

I use this all the time when the Jehovah's Witnesses knock on my door. I ask them, "How many people do you believe are getting into Heaven?" Of course they respond that they believe only 144,000 are going to make it into heaven (or whatever the number is). I then tell them that if I found out that only 144,000 people were going to make it, I'd stop knocking on doors and telling everyone about it.



 On his blog, Paul Kedrosky highlights this quote from the most recent issue of Barrons, suggesting that housing market bets extrapolating from the historical pattern changed the odds and motivated the pattern to break down:

…One of the great lessons [of investing] is beware of platitudes, such as "There has never been a national decline in home prices." If you believe that there has never been a national decline in home prices and that there never could be, then you bid home prices up to levels that don't allow for the risk of widespread losses, because you concluded it could never happen. Then the fact that they are at those new high prices introduces, in itself, the risk of a national home-price decline. So the actions of people relying on history change history, and that is what people lose track of…

Flashback: Cliff Asness applied a parallel notion to the stock market a decade ago:

…Imagine all stock prices went up 100x tomorrow with no change in fundamentals. Hopefully, we would all agree that paying about a 3000-4000 P/E for the S&P 500 right now would make a very poor long-term investment (wow, a P/E that even the author's of Dow 36,000 would not love). However, the historical average return on stocks would skyrocket once this 10,000% return was added. Obviously, in this case it would make little sense to use the historical average to forecast the long-term future. The historic average would be incredibly high, and the future would look incredibly poor. While far less extreme, the real-life situation today is analogous.

And Robert Bacon on horse betting: "…The principle of ever-changing trends works to force quick and drastic changes of results sequences when the public happens to get wise to a winning idea…"



V NThe action on the first day of the month of September was highly unusual, and apparently at that time the employment number had leaked so the moves after that first day were much more likely to happen than before. After such bad starts the rest of the week has a standard deviation of 30 and only 50% chance of rise.

The 40 point S&P decline on Thursday was the fourth largest decline on a Thursday ever. By that time, the news was out, and the increase in unemployment was icing on the cake.

All this occured in conjunction with repeated highs in the fixed income prices around the world, and declines in the omniscient market in Israel below the round and Japan near three year lows of 12000 on the Nikkei.

To me, the key event was the raising of the Swedish discount rate during the night Thursday, causing an immediate 1% decline in all European equities. How come they weren't keyed in like the others to the forthcoming announcement?

The most hurtful piece of mass psychology was the naive notion about stocks having to go down because the P/E of 25 was the highest in 15 years, and that was bearish. Earnings are forecast next quarter to be the highest increase ever of 50% and you would think that people are taught to look at the future rather than the past for moves in markets.

There were many good economic numbers and bad economic numbers in the past week relative to expectations. What is it that caused the employment number to be the focus, other than the desire to paint the economy as weak before the election for obvious reasons of agrarianism? More important, why should a decline in employment at this stage be bearish for stock markets?

The one factor that made it seem so much like the end of the world was the the four day move down in S&P from the Thursday 8 28 close of 1298 to the Tuesday 9 04 close of 1236, a decline of 62 points was the second worst start of a week since the beginning of 2002, the only comparable being the four day move on 1 17 2008 before the French bank inside trading activity.

Michael Bonderer adds:

Perhaps equally important, maybe more so: Trichet's decision to increase the haircut on collateral to 12% from 2%.

Martin Lindqvist writes from Sweden:

The Riksbank declined being part of the liquidity pump that the Fed, ECB, SNB, et al, set up last year and continued with also this year. Maybe they are deliberately kept out of the loop now? However I think it has more to do with them having gotten lot of criticism for raising the last few times. Perhaps they just want to show who is in charge.

John De Palma adds:

With respect to the market obsession with the non-farm payrolls report (to the point of motivating a scene in the movie "25th Hour"), the sensitivity of interest rates to a one standard deviation surprise in payrolls is a few times higher than any other economic indicator. The rankings of market sensitivity to the indicators look like they follow a power law distribution, the distribution that characterizes movie/book popularities and other sociological phenomena. It's difficult to create a model of the economy that conforms to the dispersion of sensitivities. It's more plausible to appeal to a view of markets with focal points, attention biases, etc.

Henrik Andersson follows up on the Swedish developments:

It turns out the Swedish calculation of inflation was flawed leading up to the rate hike and the reported July number of 4.4% was in reality 4.1 percent (they thought shoes prices had increased 30% yoy…). Since the Swedish 'Riksbank' most likely was split in their decision it is widely suspected that with correct data we wouldn't have had a hike to 4.75%.



T CowenTyler Cowen's book, Discovering Your Inner Economist has an ambitious agenda. It purports to tell you such things as:

  1. How to control and improve the world
  2. How to possess all the great art ever made
  3. How to get along with your family
  4. How to read books and go to cultural events

The style of the book is to describe one of the important goals above, show how taking into account incentives and scarcities might give us insight into it, discuss various psychological studies that indicate where the usual tools of economics might be applied, give the references to these studies in the back of the book, and cite various sites on the web, back and forth from his own site MarginalRevolution that have covered the subject, and give personal anecdotes as to how he has applied these principles in his own life.

The book is accessible to every person with no formulas or diagrams, and plenty of s&xy anecdotes and stories to keep the principles in mind. Indeed, Mr. Cowen (as he likes to be called — the Dr. would be pretentious for a man of his accomplishments) often faults economists such as Steven Landsburgh, David Friedman,and Steven Levitt for paying too much attention to the usual elements of price theory economics such as diminishing marginal productivity and utility, movements along and shifts of supply and demand curves, gains of trade and specialization, fixed versus marginal costs, marginal rates of substitution, profit maximization, rational expectations, on the grounds that they don't take into account the psychology and evolution of human behavior, especially the need of humans to achieve self-esteem and control.

The main weakness of the book is that the psychological studies he cites are mainly constructed in laboratory settings. They don't take account of the many factors that humans actually consider when making real life decisions. Most of these decisions do involve gains and trade and the classical principles of economics to me provide a much sounder framework and foundation for making sound and measurable decisions than the often spongy connections in the studies he cites, including the many studies on the importance and prevalence of signaling. I believe in almost all the cases cited, the businesses, persons and institutions have developed profit maximizing and rational behavior that explains their actions and that they are not acting against their economic self interests.

Parking Ticket Mr. Cowen gives three stories that are helpful in navigating the world we live in. The Parking Ticket story explores the reason for the distribution of parking tickets by countries from diplomats at the UN. The idea is that those who come from a culture of honesty and trade have few violations, and those who come from corrupt countries don't. The Car Salesman story shows why it is good to use commissions as incentives in simple cases. The Dirty Dishes story tells why you can't get your kids to wash dishes by offering them rewards. I wish the author had used more parking ticket stories to explain the phenomena he adduces as the reader would end up with something more valuable than the hoped-for psychology that explains the other. There are valuable philosophic insights that provide the foundation for this book- namely that "the West has succeeds as much as it has because it embraced the values of self-criticism, individual rights, science, and the idea that government is the servant of the people not vice versa". He goes on to suggest that prudence, critical self-reflections, belief in higher values and wisdom in matters of ordinary life are the keys to a better future.

 The most interesting part of the book to me were the many markets that have developed in amazing areas like the market for making beggars really disabled, the market for writing love and breakup letters, the market for getting a guide who won't promote you in Morocco. I wish that the book had provided more economic principles that explain the structure of such markets. However, even if unsupported by empirical evidence or a framework of testable principles, the book contains many startling and useful ideas, e.g. ordering the menu items that sound and look the worst, and reading 10 books or movies at a time and finishing only two of them, stopping doing routine errands and do only the most important things, trying to deceive yourself into thinking you are worthy, that cry out for testing and practice. I can recommend this book to all market people as one that they will think about in many of their decisions.

John De Palma adds:

You wrote: "… The main weakness of the book is that the psychological studies he cites are mainly constructed in laboratory settings. They dont take account of the many factors that humans actually consider when making real life decisions…"

A study just came out with data based upon real world decision-making on whether to go to trial. It is an interesting data set compared to data generated by psychology experiments done on college classes and then generalized as if it's universal human behavior and not just an artifact of a contrived experimental backdrop. The New York Times wrote about the study on Friday:

"Note to victims of accidents, medical malpractice, broken contracts and the like: When you sue, make a deal. That is the clear lesson of a soon-to-be-released study of civil lawsuits that has found that most of the plaintiffs who decided to pass up a settlement offer and went to trial ended up getting less money than if they had taken that offer(…)Defendants made the wrong decision by proceeding to trial far less often, in 24 percent of cases, according to the study; plaintiffs were wrong in 61 percent of cases. In just 15 percent of cases, both sides were right to go to trial — meaning that the defendant paid less than the plaintiff had wanted but the plaintiff got more than the defendant had offered(…)the findings, based on a study of 2,054 cases that went to trial from 2002 to 2005, raise provocative questions about how lawyers and clients make decisions, the quality of legal advice and lawyers' motives (…) The findings are consistent with research on human behavior and responses to risk, said Martin A. Asher, an economist at the University of Pennsylvania and a co-author. For example, psychologists have found that people are more averse to taking a risk when they are expecting to gain something, and more willing to take a risk when they have something to lose (…)"

(Flashback: One of the co-authors, Blake McShane, had a post on your site here on an unrelated issue) .



V N In evaluating economic forecasts, one should consider the null hypothesis, which is Milton Friedman's, that the expected change in GNP next quarter, adjusted for part/whole effects and overlaps, is a constant 3% a year, regardless of the previous conditions.

John De Palma replies:

GDP forecasts of Wall Street economists and the Fed improve only a bit on "naive, same change" predictions (i.e. predictions that "future growth rate will be the same as the most recently observed growth rate"). Former St. Louis Fed President William Poole summarized research on forecast accuracy as part of a February 2004 speech:

"(…)The authors compared the Blue Chip forecasts, the Greenbook forecasts, and the FOMC members' forecasts against a naive, same change, forecast beginning in 1980 for both real output growth and inflation. Three different forecasting horizons were examined: six, twelve and eighteen months. Not surprisingly, the accuracy of the forecasts deteriorates as the forecasting horizon is lengthened. For a one-year-ahead forecast, the root-mean-squared forecast error (a measure of the dispersion of the forecasts around the realized value) for real output growth is on the order of 1.4 percentage points for all three sets of forecasts considered. The root-mean-squared forecast error for the naive constant change forecast is considerably larger, on the order of 2.2 percentage points.

Clearly, the forecast accuracy of the forecasters is substantially better than that of the naive forecast, but still leaves a lot of room for surprises. To make this point clear in today's context, if for convenience we say that the GDP growth forecast is 4½ percent over the four quarters ending 2004:Q4, then one standard error leaves us with a forecast band of 3 - 6 percent growth over this period. If we were to have a 3 percent outcome, everyone would fear that the recovery is faltering; if we were to have a 6 percent outcome, the most likely characterization would be that we have a boom on our hands(…)"



 Tyler Cowen gave an interesting talk at the NY Junto about the economics of worry, what you should worry about and what you shouldn't. He touched on his bearish views for the stock market, and felt Dow 8000 was a good goal because of the conjunction of the real estate and commodity crises, and various psychological anomalies. I kept wanting to say "Et tu, Tyler?" because I don't believe in bear markets, and always believe it's right to buy, especially at times like this.

John De Palma adds:

I greatly enjoyed the lecture on Thursday. It was the best talk I've attended this year.

1) He attributed part of the origin of the subprime problem to a calculation error where the perceived default rate could have been 1% in securities when the true probability of default was 4%. (Somewhat relatedly, Richard Clarida wrote in an October PIMCO commentary, "The proximate cause of this 'hard day's Knight' was the more or less simultaneous realization by millions of global investors that their underlying assumption about the distribution of returns on a wide "variety of asset-backed securities" was fundamentally flawed.")

I also think a rational bubble was a source. The Keynesian beauty pageant as an asset pricing model could be consistent with buying and selling of assets at values that adhere to an overall market convention that is inconsistent with how each market participant would appraise the asset if unable to flip it to another participant. (Keynes BTW compared investment to "a game of Snap, of Old Maid, of Musical Chairs"). In my view the bursting rational bubble would just be a breakdown in the pricing convention.

If a bond fund manager gets evaluated by Morningstar ratings and receives capital inflows on the basis of a narrow trailing 2 or 3 year performance, then the incentives to harbor blowup risk in a portfolio is such that the manager marginally setting prices in the market could be apathetic about whether he privately believes that default rate is 1% or 4%.

It conjures up an interesting thought experiment: Can credit risk be underpriced and yet everyone in the market thinks bonds are overvalued? Or the parallel inquiry from a rational bubble section of my senior thesis in college: Can eToys be worth $10 billion when mutual fund managers collectively think it is worth $1-$2 billion? (I surveyed fund managers, many of whom owned the stock, and the average response was the latter figure at a time when the market cap was multiples higher.)

2) I liked how Cowen's view of the macroeconomy was nuanced instead of a one dimensional scapegoating of an overly accomodative Fed, over (or under) regulation, etc. that is so popular. I find scary the compulsion towards narrative fallacies, attribution errors, and cramming world events into a preexisting ideological view.

3) His metaphor comparing subprime securities to poisoned water seemed apt. Bill Gross chose a "Where's Waldo" metaphor to eloquently make the same point in some of his commentaries during the financial crisis– ("…While market analysts can guesstimate how many Waldos might actually show their face over the next few years - 100 to 200 billion dollars worth is a reasonable estimate - no one really knows where they are hidden…"). In analyzing earlier crises Mohamed El-Erian has also related the lemons problem to EM debt pricing.

4) Cowen spoke about how the inequality of happiness in Denmark is similar to the U.S. despite a lower income inequality there. My takeaway from Daniel Gilbert's book was happiness set points and the power of habituation. Couldn't the inequality of happiness just converge upon some distribution regardless of the level of income inequality if there haven't been recent changes?

Also, I think in Gilbert's book there is an assertion about how the most realistic people (i.e. least susceptible to cognitive biases) are ones that are classified as mildly clinically depressed. Similarly, if people generally worry too much (which seemed to be your contention even if there are certain things people worry insufficiently about), then maybe some self delusion would be useful to avoid excess sensitivity to perceived threats.

5) In general comments on income inequality he mentioned how the rate of inflation varied by income right now. This is a bit of a non sequitur, but it's a topic I've been thinking about in the context of the Fed's fervent interest in inflation expectations. Surveys show how expectations differ by region and even gender in normal conditions. People's expectations have a consistent upward bias and overweight more frequent purchases. If the Fed is so obsessed with controlling these expectations than perhaps we need separate monetary policies by region, gender, and income so that we can reset an expectations-augmented Phillips curve to a price stability point. Since we of course don't, then maybe the Fed and market participants shouldn't look at these surveys to the second decimal place and pretend that the fate of the economy depends on 1.8% vs 2.2% inflation.

6) He made a point on health care about how people are blindly deferential to not properly incentivized doctors reminded me of this good column that David Leonhardt wrote in November– ("… Economists sometimes refer to this situation as an "expert service problem," because the same expert who is diagnosing the flaw is the one who will be paid to fix it. In most of these cases, consumers aren't sophisticated enough to make an independent judgment. That's why they went to the expert. The problem, of course, extends well beyond the car business. Anytime you call a plumber or roofer to your home or anytime you visit a doctor or dentist, you're at risk of having an expert service problem…If anything, Professor Hubbard argues that the expert service problem is more serious in medicine than in auto repair, because most people are less willing to question a doctor than to question a mechanic. Any effort to reform American medicine has to grapple with these conflicts of interest…").

7) Cowen commented that a catastrophe isn't more likely because markets don't price the prospect more aggressively now than in the past. However, in an article he linked to on his blog, Peter Thiel said the pricing is distorted because no one would be around to collect the insurance payout in the event of the catastrophe– ("…The catastrophe is so large that no functioning market or government remains: This is the only case where one would incur catastrophic "losses," although nobody might be left to collect them…" ) Similarly, there was recent speculation that a market on a Large Hadron Collider-motivated catastrophe would break down because of the inability to collect a payout in an apocalyptic event. ("…Unfortunately this is one kind of question where an Idea Futures market would not work too well, because people who correctly bet that the reactor will destroy the earth may not be able to collect their winnings. This would cause the market to under-estimate the risks…")



Tyler Cowen wrote a piece on why the Rockets drafting injury-prone center Yao Ming was like writing a naked put.

"…So why did the Houston Rockets draft Yao Ming? They couldn't not draft him. The lessons for financial markets are obvious. Drafting Yao Ming is like writing the disguised naked put. You see the money in front of you, you see the return in front of you, you see the potential in front of you, none of the alternatives are so glamorous, and so you can't not do it. Besides, other players get injured too…"

Perhaps the metaphor makes sense to the extent writing puts and drafting an injury-prone player both have asymmetrical reward structures with divergent modes and means. But Cowen seems to be inappropriately disparaging both activities. Writing equity index puts has historically been profitable. And at least in baseball it appears a GM can sign injury-prone players at a sufficiently large discount to be more than fully compensated for the risk.



 1. "Electrocybertronics," an article in Smithsonian, March 2008 issue, points out some sexy company names, especially suffixes, from the last century starting with electric, going to "ex," then "ola" then "tronics" then "cyber" then "nano." I made a preliminary study of returns the 35 US public companies with "nano" in their names and found that most of them are near zero and have not risen in price. I can't pass this subject without noting that like most new things, those who wish us to remain primitive are fighting against this development, and much life-saving will be prevented. Apparently there are nano pants that stay clean, and perhaps this will play the same role that hybrid seeds played in opening up biotech in opening up life extension and reduction of human drudgery in nanotech.

2. We've now had the greatest number of down S&P opens in a row in history at six. And that's surprising since it's only a 1 in 64 shot.

3. How often can people take one city, one month, and send the market down a few percent, as they did with Chicago Purchasing Managers, only to reverse it the next day when the next random number, such as NAPM, comes up.

4. In "The Mauritius Command" by Patrick O'Brian there's a beautiful passage about how Mauritius bonds are trading at only 10% on the dollar recently from 80% as they follow the probabilities of success of Aubrey's imminent invasion and his recent results against the French. Very much similar to the movements in the market as Democratic prospects for victory wax and wane.

Easan Katir writes:

Vic's post stirs memories. To properly observe a mid-life crisis at age 43, I sold my book and moved to a beach house in Mauritius, about 100 yards from Point aux Cannonieres, the fort from which the French defended their island against the British in 1810. One could easily imagine those frigates in full battle. O'Brian mentions the monsoon. A few months after we moved in, a category 5 hurricane's eye passed directly over our house I can't imagine how ships of that day withstood these monsters.

So the nanos have gone the way of the Mauritian dodos. Two more words to add to the 100-year historical list might be 'railroad' and 'mining' as most of those went to zero, and more recently 'bio.' The takeaway message is be on the lookout for the next fad name. We are right in the middle of the crash of any name containing the word 'finance.' Perhaps any name with 'solar' is on deck next, unthinkable as that may now seem.

John De Palma adds:

You wrote today: "In "The Mauritius Command" by Patrick O'Brian there's a beautiful passage about how Mauritius bonds are trading at only 10% on the dollar recently from 80% as they follow the probabilities of success of Aubrey's imminent invasion and his recent results against the French. Very much similar to the movements in the market as Democratic prospects for victory wax and wane."

I'm reminded of how historian Niall Ferguson studied whether bond markets anticipated World War I, discovering that they did not: "…Ferguson is intrigued by the behavior of the financial markets on the eve of World War I because stock and bond prices at the time registered scant concern about the impending cataclysm. This contrasts with the conventional view among historians that the war was all but preordained because of a decade of escalating great-power rivalries that erupted into violence after the assassination of an Austrian archduke by a Serbian terrorist in June 1914… Ferguson was most surprised that the people who had more to lose from a war "bond investors" didn't see it coming…" 

Similarly, before the Iraq war, Penn economist Justin Wolfers ran regressions of changes in various financial assets against changes in the TradeSports Saddam contracts. He inferred the extent to which an anticipated war was built into financial market pricing and objectively determined what the impact of the war was on markets. Also, MIT economist Michael Greenstone analyzed the Iraqi bond market to gauge whether the country would survive.



 In the Q&A yesterday, before the House Committee on Financial Services, Bernanke said: 

"…the fact that there are some very wealthy people doesn't necessarily make me or you worse off if they're creating value. You know, I'm a baseball fan. I like to watch Alex Rodriguez. And I don't particularly care that he earns a lot more money than I do."

What Bernanke might have been implicitly referencing:

"…End state" entitlement theories require continuous interference in people's lives. For example, argues Nozick, if people choose to give their money to Wilt Chamberlain (boy, are we dating ourselves), and Chamberlain gets rich, then the state redistributes his wealth for the sake of equality. And the next year when we go to the Lakers' game and give Wilt more money, the state will have to come in and seize it again, and again, and again, and again, forever.…"



Here is the Fed model update from the second section of the Monetary Policy Report that Bernanke submitted today:

…The spread between the twelve-month forward earnings-price ratio for the S&P 500 and a real long-run Treasury yield–a rough gauge of the equity risk premium–narrowed a bit and now stands close to the middle of its range of the past few years (…)

Separately, here's the art world's doppelganger of Alan Sokal.

Victor Niederhoffer replies:

A much better effort is the empirical regression of forecasted earnings e/p versus bond yield as the independent variable, and stock price change as dependent, as in my work with Laurel and Tom Downing.



Here is a pair of interesting links. One pertains to labor market efficiency (at least in baseball) that could be applicable to stocks. The other summarizes interesting recent research on synesthesia.



From A Strategy That Deserves a Double Take, in The New York Times:

Even though swinging on a 3-0 count produces significantly higher batting averages and slugging percentages than waiting for 3-1 or 3-2, batters are going after fewer 3-0 pitches than at any time in the past 20 years.… Still, Forst said this was cyclical. Pitchers will eventually become more aggressive with their fastballs, prompting some hitters to start cranking it up again, and bringing the threat and excitement back to the 3-0 pitch. 



 There are two interesting articles about people’s attitudes towards superstition and the role it plays in our daily lives. One appears in Live Science:

"Those superstitious types who freaked out last year when the calendar read 06/06/06 will have something to smile about on the 7th day of the 7th month, 2007. Believing the triple appearance of the number 7 will bring luck, many people are planning important events for this first Saturday in July … Just as some people wouldn't dare get married on a Friday the 13th or live in a house with the address 666, believing in the positive influence of the number seven is just another technique humans use to have some jurisdiction over the chaotic world around them, said Frankfurter. "In our modern American society we have a tendency to look for magical ways to control the world or fate, so numerology is especially important for us," Frankfurter said. The obsession with numerology-and other para-sciences like astrology-tends to get stronger especially during significant life events … "It represents Americans' rather weak (compared to Asian cultures') attempt to exert some numerical or calendrical control over important life-cycle, transition, or other crisis situations,"…Lucky numbers also vary from culture to culture, proving, skeptics say, that coincidental connections between an event and the influence of a number can always be found if you're looking hard enough, no matter what the digit…" 

Another appears in the Wall Street Journal.

"In January 2005, NyLon Capital LLP of the U.K. launched with much fanfare a $1.2 billion high-profile hedge fund, backed by a blue-chip bank and run by some of the brightest stars of London's financial community. Within 15 months, the shine was gone…Claims lodged in the U.K.'s High Court allege that business decisions taken by the fund's top manager were influenced by an astrologist and a feng shui expert and this destroyed the relationships between the partners. The fund acknowledges that a consultant in feng shui, a Chinese geomantic practice, was employed and says the top manager is acquainted with an astrologist…Mr. Crapanzano alleged in another document filed in the U.K.'s High Court in February of this year that some of Mr. Burnell's business decisions relating to the other partners were influenced by France Jacoubet, a French astrologist. He said Ms. Jacoubet drew up horoscopes of all the fund's partners and employees to see whether they would fit into the company. Reached by telephone, Ms. Jacoubet declined to comment. Mr. Crapanzano also alleged that Mr. Burnell hired a feng shui consultant to conduct "good fortune" assessments of the fund's offices and oversee spiritual cleansing rituals, which involved placing small figurines of trolls, or ogres, in desk drawers and placing piles of sand and pebbles in the corners of the office…" 



A new study published by the American Psychological Association:

"Whether people are making financial decisions in the stock market or worrying about terrorism, they are likely to be influenced by what others think. And, according to a new study in this month's Journal of Personality and Social Psychology, published by the American Psychological Association (APA), repeated exposure to one person's viewpoint can have almost as much influence as exposure to shared opinions from multiple people. This finding shows that hearing an opinion multiple times increases the recipient's sense of familiarity and in some cases gives a listener a false sense that an opinion is more widespread then it actually is …" 



In comments earlier this year the Chair wrote, "When will someone explain to Fed. Governors that the stronger the economy, the less likelihood there is of inflation, as there is expansion to absorb the money supply."

Sympathetic to your view, Dallas Fed President Richard Fisher wrote the following in a Wall Street Journal op-ed earlier this month: "… faster output growth dampens inflationary pressures … A new formula emerges from an economic model being developed by the Federal Reserve Bank of Dallas. It reveals something the traditional doctrine misses: Inflation varies inversely with growth not only in the domestic economy but also with growth in other countries…".

Also, one of the Bloomberg top stories last week was about how "Most Americans See Recession in the Next 12 Months." I channeled the Chair in my reply to it. See update 2 to the entry entitled "Expert Testimony" on Donald Luskin's blog.



 Her is a good case study in attribution errors, illusion of control, and other cognitive biases that relate to financial markets.

In memory of Kurt Vonnegut, from Slaughterhouse Five:

"It was about an Earthling man and woman who were kidnapped by extra-terrestrials. They were put on display in a zoo on a planet called Zircon-212. These fictitious people in the zoo had a big board supposedly showing stock market quotations and commodity prices along one wall of their habitat, and a news ticker, and a telephone that was supposedly connected to a brokerage on Earth. The creatures on Zircon-212 told their captives that they had invested a million dollars for them back on Earth, and that it was up to the captives to manage it so that they would be fabulously wealthy when they were returned to Earth.

The telephone and the big board and the ticker were all fakes, of course. They were simply stimulants to make the Earthlings perform vividly for the crowds at the zoo–to make them jump up and down and cheer, or gloat, or sulk, or tear their hair, to be scared shitless or to feel as contented as babies in their mothers' arms.

The Earthlings did very well on paper. That was part of the rigging, of course. And religion got mixed up in it, too. The news ticker reminded them that the President of the United States had declared National Prayer Week, and that everybody should pray. The Earthlings had had a bad week on the market before that. They had lost a small fortune in olive oil futures. So they gave praying a whirl.

It worked. Olive oil went up."

Also, from a column by Bloomberg's Mark Gilbert:  

One of the tests featured a chart on a computer screen. The line on the graph started at zero, and then increased or decreased every half-second for 50 seconds. The traders were told that pressing keyboard keys Z, X or C might affect how the chart developed. When the chart stopped moving, they were asked how much influence they thought their typing had on the chart.

The test was a placebo. The typing had zero effect on how the graph developed. While some traders realized the chart was predetermined, others were convinced they had full control. (The mental image of a guy in shirtsleeves bashing impotently at a keyboard, convinced he's making a difference, is very appealing. Not so different from what he does for 10 hours a day, maybe.)

`The results produced a statistically significant negative association between illusion of control and both total remuneration and desk profits, but not risk management, analytical ability or people skills,' the authors wrote. `There is a clear case for saying illusion of control is associated with poorer performance and lower earnings.'



 A recent NY Times op-ed reminds me of your Junto remarks last Thursday about how insider buying can transmit a deceptive signal. Daniel Gilbert's op-ed has some examples of other potential false signals. Gilbert wrote:

"In an advertising campaign that began last week, Nissan left 20,000 sets of keys in bars, stadiums, concert halls and other public venues. Each key ring has a tag that says: "If found, please do not return. My next generation Nissan Altima has Intelligent Key with push-button ignition, and I no longer need these." …There is no selfish reason to bend down and pick up a key ring, but Nissan knows that we will bend without thinking because the impulse to help is bred into our marrow. Our best instinct will be awakened by a key ring and then punished by a commercial. Like rubes throughout the ages, we will be lured by a false cry of distress and quickly cured of our innocence and compassion. We are used to commercial tricks that play on our fears. The official-looking letter marked "Verification Audit" is actually a magazine subscription renewal form; the credit card company's ominous call to "discuss your account" is actually an attempt to sell new services…" 

Gordon Haave adds:

The biggest investment disaster I have been a part of was Edison Brothers Stores, which went to zero. A couple of months before it went under, all the directors bought some shares on the same day. After the fact, it was clear that it was doomed when they purchased. It was a clear head-fake.



 The odds of one person's filling out a perfect bracket for the NCAA basketball tournament, i.e., the odds of picking every single game winner correctly is nine quintillion to one.

Another way to view this is that if every person on the planet were to randomly fill out one million sheets the chances would be one in 1000 that a perfect sheet would be found.

The odds of picking the five numbers in the Powerball lottery are one in 3,563,609 but to pick all five numbers and the powerball are one in 146,107,962.

Alston Mabry writes:

If the tournament were a coin-tossing exercises, there would indeed be 2^63 = nine quadrillion outcomes. But can we improve those odds?

Looking at the NCAA Tournament results for 2005 and 2006, 86 of 126 games were won by the higher-seeded team, a 68.3% win rate for the NCAA seeding committee. If the seeding were random, one would expect a win rate of 50% with a 4-5% standard deviation, so the committee's results are inconsistent with randomness.

If you go further and rank the games by the difference in seeding (low seed minus high seed, so that a one seed playing a 16 seed would be a 15-spread game), and then look at the quartiles, you see that the committee is even more successful. The first column is the average difference in seeding between the teams in the quartile, and the second column is the rate at which higher-seeded teams won in that quartile:

seed diff / win rate
12.29 87%
7.79 75%
4.25 69%
1.27 42%

Andy Moe remarks:

 I would suggest that spreads and seedings should be examined closely in the tournament, as there are statistically significant edges that can be of use both at the sportsbook and in an office pool. For the most part, I believe the edges are present because the tournament selection committee is better at seeding the teams than the general public is. Add plenty of "amateur" money chasing favorite schools and you have the perfect recipe for mispricings.

The memes surrounding the tournament are surprisingly similar to those found in the markets. The length of time since a #16 seed beat a #1, the danger of the #5 vs #12 matchups, past greatness of teams, coaching vs players, upset specials, giant-killers, hot hands, the list goes on and on. Thankfully, almost all of this centers on how to pick winners, not how to beat the spread.

So while the rest of America concentrates on filling in brackets, I'll be packing my bags for Vegas. As in the markets, it pays to know when to break out the cane and hobble down to the sportsbook.

From John De Palma:

From the New York Times

"When it comes time to pick a champion in an N.C.A.A. bracket, people tend to cluster around a few of the favorites…. At first glance, this focus on the favorites seems to make perfect sense. History suggests that the top-ranked teams really are more likely than other teams to win the tournament. If you cared only about picking the correct national champion, it would be smart to choose a team like Ohio State or Kansas this year. The problem is that you would have a lot of company. To finish at the top of your pool, which is what matters to most people, you would have to do extraordinarily well in the rest of your bracket … The lesson is basic: As long as everyone else is clustering around a couple of favorites, you hurt your chances by joining them … But pools do make a broader point about human behavior. Frequently, people make decisions without fully taking into account the actions of others. Investors, for instance, may buy stock because they believe a company will do well in coming years, but they fail to consider the possibility that the stock price already reflects that information…"



 Five years ago I read here about "the inordinate tendency of companies that bought the rights to name stadiums after themselves to fall into bankruptcy, financial difficulties, or drastic declines in market value." A Bloomberg article from today offers another data point towards that pattern:

ACC Capital Holdings' need for a financial lifeline from Citigroup Inc. is the latest sign that putting a company's name on a sports stadium doesn't guarantee its business will thrive. Ameriquest Mortgage, the Orange, California-based company's subprime mortgage unit, signed a naming-rights agreement in May 2004 with Major League Baseball's Texas Rangers. The 30-year contract was valued at $75 million … ACC Capital is hoping to avoid the fate of Enron Corp., which named the home stadium of baseball's Houston Astros and then went bankrupt. The field is now called Minute Maid Park. Citigroup knows about naming rights as well as mortgages. The New York Mets' new stadium, scheduled to open for the 2009 season, will be known as Citi Field under a 20-year agreement between the New York-based company and the team.



 Late last month, New York Times writer John Tierney posted a good description of cognitive dissonance. To what Tierney wrote, I'll add another cognitive dissonance experiment that has obvious market parallels.

From Robert Cialdini's "Influence: The Psychology of Persuasion" comes:

"A study by a pair of Canadian psychologists uncovered something fascinating about people at the racetrack: Just after placing a bet, they are much more confident of their horse's chances of winning than they are immediately before laying down that bet. Of course, nothing about the horse's chances actually shifts; it's the same horse, on the same track, in the same field; but in the minds of those bettors, its prospects improve significantly once that ticket is purchased … Thirty seconds before putting down their money, they had been tentative and uncertain; thirty seconds after the deed, they were significantly more optimistic and self-assured. The act of making a final decision - in this case, of buying a ticket, had been the critical factor. Once a stand had been taken, the need for consistency pressured these people to bring what they felt and believed into line with what they had already done …". 



Harvard psychologist, Steven Pinker, wrote in a recent issue of Time magazine (The Mystery of Consciousness):

… Take the famous cognitive-dissonance experiments. When an experimenter got people to endure electric shocks in a sham experiment on learning, those who were given a good rationale ("It will help scientists understand learning") rated the shocks as more painful than the ones given a feeble rationale ("We're curious.") Presumably, it's because the second group would have felt foolish to have suffered for no good reason. Yet when these people were asked why they agreed to be shocked, they offered bogus reasons of their own in all sincerity, like "I used to mess around with radios and got used to electric shocks." …

One sees echoes of this in the macroeconomic analyst or trader who manipulates incoming information to fit a preexisting view/position.



Last week, the New York Times had a good article on Magical Thinking.

… Psychologists and anthropologists have typically turned to faith healers, tribal cultures or New Age spiritualists to study the underpinnings of belief in superstition or magical powers. Yet they could just as well have examined their own neighbors, lab assistants or even some fellow scientists. New research demonstrates that habits of so-called magical thinking - the belief, for instance, that wishing harm on a loathed colleague or relative might make him sick - are far more common than people acknowledge …

In another experiment, the researchers demonstrated that young men and women instructed on how to use a voodoo doll suspected that they might have put a curse on a study partner who feigned a headache. And they found, similarly, that devoted fans who watched the 2005 Super Bowl felt somewhat responsible for the outcome, whether their team won or lost …



The NY Times last week printed an article about how the Dallas Mavericks have a free-throw coach (Investing in Free Throws Pays Off). It is a good case study in developing an edge. The article also touches upon overconfidence biases and systematic methods of improvement:

The Dallas Mavericks, the N.B.A.'s top team this season, are no strangers to winning ways, but in getting an edge on opponents over the past several years, they have gone beyond sheer talent. The Mavericks have what amounts to a secret weapon in Gary Boren, an investment banker who is the N.B.A.'s lone free-throw coach … Boren begins by filming the players shooting free throws … There are 41 common problems that Boren is looking for in the footage, but he cautions that merely telling a player what he is doing wrong will not help him. He must first deal with the mental barriers that players put up. "They all think they're better shooters than they are," Boren said … "I'm trying to take what they've got - because they've already shot thousands of shots - and tweak their shot in the most important areas that will give them a shot to get better." Even when the player wants to learn, Boren must conquer another barrier. He tells them: "When I look at you, I see two things - a brain and a bunch of muscles - and the good news is the brain is really clicking. But the bad news is your muscles have been taking a siesta. They like it the old way and they're not paying attention to any of this stuff. So when we get down there, they're going to resist." … Despite Boren's success, no other teams have hired a free-throw coach.

In a blog post last year, Mavericks owner, Mark Cuban, wrote something that serves as almost a prologue to this NY Times piece:

When I got to the Mavs, I talked about putting the players in a position to succeed by hiring more coaches. After all, if we have a multimillion dollar investment in a player, it only made sense to me to provide that player with whatever individual instruction that was necessary to make them better. To put them in a position to succeed. [Read more here]

Interestingly, for 12 years, Boren followed around former Mavericks coach/current Warriors coach Don Nelson. One of The Wages of Wins (a Moneyball type book) authors offers statistical support of Don Nelson's coaching performance, at least some of which could presumably be attributed to Gary Boren:

One paper I am currently working on is an examination of NBA coaching. The paper is co-authored with Mike Leeds (Temple) and Mike Mondello (Florida State) and gradually it's nearing completion. Our tentative results thus far indicate that some coaches, although not all, appear to have a positive impact on player performance. One of these coaches is Don Nelson. [Read more here]

The NY Times article on Boren is reminiscent of this excerpt from Michael Lewis' feature on the Texas Tech's Mike Leach:

… Schwartz had an N.F.L. coach's perspective on talent, and from his point of view, the players Leach was using to rack up points and yards were no talent at all. None of them had been identified by N.F.L. scouts or even college recruiters as first-rate material. Coming out of high school, most of them had only one or two offers from midrange schools. Sonny Cumbie hadn't even been offered a scholarship; he was just invited to show up for football practice at Texas Tech. Either the market for quarterbacks was screwy - that is, the schools with the recruiting edge, and N.F.L. scouts, were missing big talent - or (much more likely, in Schwartz's view) Leach was finding new and better ways to extract value from his players. "They weren't scoring all these touchdowns because they had the best players," Schwartz told me recently. "They were doing it because they were smarter. Leach had found a way to make it work." [Read more here]

In a column two years ago, Bloomberg columnist, Mark Gilbert, suggested a financial market parallel to all of this:

The authors reserved their most scathing comments for the way trading rooms are managed. "Trader management is a training-free zone,'' they said. "In a combined 70 years of experience, the authors have never encountered so little management development in sophisticated organizations of vast resource." Banks are happy to leave traders alone provided they are making money. Managers only intervene when a trade has gone sour; post-mortems are held when money is lost, with scant investigation of why some trades are profitable. "The combination of trader autonomy, reliance on bonus and management spans of control generates an environment where managers see themselves as a safety net rather than as creators of value or profit," the professors said. "Put another way, trading environments rely too much on managing outputs." [Read more here]

As an aside, this isn't the first time the NY Times wrote about Mark Cuban's innovative approaches to free throw shooting. In the 2005 NY Times magazine "year in ideas" issue, one of the discussed ideas was as follows:

The key to a successful free-throw defense, Engber argues, is to make a player perceive a 'field of background motion' that tricks his brain into thinking that he himself is moving, thereby throwing off his shooting. In other words, fans should wave their ThunderStix in tandem. Last season, Engber proposed this tactic to the Dallas Mavericks' owner, Mark Cuban, who took him up on the idea. For three games, Cuban had members of the Mavs' Hoop Troop instruct fans to wave their ThunderStix from side to side in unison … [Read more here]

John De Palma further adds:

Providing some indirect color on the difficulty of shooting free throws intermittently after running up and down the court, Jack Schwager's "Stock Market Wizards" quotes psychiatrist Ari Kiev:

There are some common denominators, but different sports require different mental frameworks. For example, in bobsledding, you need to start off with a maximum amount of exertion as you run and push the sled. But as soon as you get into the sled, you have to slow down your adrenaline so that you are calm and centered while steering the sled down the course. A similar transition is required in the biathlon, where the athletes race on cross-country skis, with their heart rate exceeding 120 beats per minute, and then have to stop and focus on shooting a target, with their heartbeat ideally slowing down to 40 beats per minute.



The Wall Street Journal article earlier this month on sports handicapper, Bob Stoll (The Man Who Shook Up Vegas), has already become a meme, but I want to revisit it and draw a few parallels with other writings on speculation …

From the WSJ article:

Although he makes a living handicapping college and pro football and basketball, Mr. Stoll rarely visits Las Vegas. He's never placed a bet in one of the city's sports books and hasn't attended an NFL game since he was 9. He does not make a habit of watching sports on TV. "Your eyes can only fool you," he says.

From Michael Lewis' "Moneyball" (referencing Oakland A's GM Billy Beane):

Billy hadn't the slightest intention of watching his team make history. It was just another game, he said, and he didn't watch games. "All they provide me with is subjective emotion," he said, "and that can be counterproductive."

From the WSJ article:

Put him in a different setting and he might be running a hedge fund, developing office towers or monitoring the currency markets.

From "Moneyball" (referencing then-A's assistant GM Paul DePodesta):

He was just the sort of person who might have made an easy fortune in finance, but the market for baseball players, in Paul's views, was far more interesting than anything Wall Street offered.

From the WSJ article:

But in 2005, Mr. Stoll noticed that a few minutes after he sent his advice, the lines on those games would shift slightly … While the line moves were flattering at first, they quickly became a problem … The bookmakers had clearly subscribed, he says, and were trying to change the lines before his clients could make bets … The more the point spreads move, the less effective his advice becomes. And when the bookmakers figure him out, his disciples will drift away.

From Education of a Speculator:

These oh-so-fleeting hot hands of market gurus become clarified. An advisor comes up with a successful prediction. For example, Bob Prechter, Elaine Garzarelli, and Mario Gabelli picked the big crash in October 1987. They become prophets. Their followers were flush, and they told their friends about their newfound gurus. But then their fills from following the recommendations of the gurus became a lot worse because they were taking their following with them.

From the WSJ article:

If there's one bedrock law of sports gambling, it's that the people taking bets, the bookmakers, always win. Some of this is due to the haplessness of average bettors, or "squares," who never fail to make dumb wagers. The rest is a matter of design. By taking commissions on bets and using oddsmaking tools like point spreads and bet limits, the world's bookies have engineered the system to their favor.

From "Education of a Speculator":

No one doubts that the public must lose at the races in order to pay for the prize money, stable care, employees, and upkeep of the land, building, and equipment … If they bet like other members of the public, they know they'll lose … Bookie often told me that he had the best job in the world. He was guaranteed a profit on every transaction … If only public speculators would pay as much attention to -what Mark Cramer, my favorite horse racing author, calls - the "gravitational pull of the house take," as horse betters do, the public would have lots more chips.

From the WSJ article:

It's a story Mr. Stoll says he's heard thousands of times from clients who don't look at the long term. Even good bets lose 40% of the time, he says, but some clients don't grasp that. "They think I'm either hot or I'm cold."

From your column on "hot hands":

Most researchers who have studied hot hands conclude the concept is a myth … Yes, a 3-for-3 shooter or batter feels that he has a better chance of hitting the next time up. Yes, when stocks go up three weeks in a row, everyone's bullish, and when they go down three weeks in a row, everyone is bearish. The problem is that card players and dice players feel this, too. After filling in a few flushes, you are "in the zone."

The WSJ article also offers a discussion of the statistical bent of Bob Stoll's approach as well as the immense amount of research necessary to develop an edge.

And in a CNBC interview last Friday, Bob Stoll made some interesting comments that suggested how sentiment distorts betting odds:

When a team is looking as bad as they can possibly look in recent weeks that's probably the time to bet on them actually. The harder a game is to bet the better bet it is usually.



 A few quick thoughts on George Gilder's talk on Thursday …

Gilder's comments on the randomness/unpredictability of the creative process (and its resistance to central planning) reminded me of The Fountainhead because of the obvious intrinsic motivation of Howard Roark.

From a conversational exchange between Ellsworth Toohey and Peter Keating:

Does he like money? No. Does he like to be admired? No.

Gilder discussed the impossibility of modeling creativity. But there are some guesses at the distributional arrangement of total output:

Lotka, Price, Pareto and, most recently, in his wonderful book, Human Accomplishment, Charles Murray have studied the extremes of human accomplishment in literature, science, and the arts. Murray also developed some of the statistics of sports accomplishment. The models of these authors are power law statistical distributions of the form … [Read more here]

 There's also some indication of predictabilities in the individual timing and cross-sectional clustering of creative acts [Read article here]

Claude Shannon was a protagonist of Gilder's talk. Here's an excerpt about him that I just read in Fortune's Formula:

Shannon was the not the first great scientific mind to suppose that his talents extended to the stock market. Carl Friedrich Gauss, often rated the greatest mathematician of all time, played the market. On a salary of 1,000 thalers a year, Euler left an estate of 170,587 thalers in cash and securities. Nothing is known of Gauss's investment methods.

Gilder's remarks about how supposed "deflation" harmed the telecom sector were parallel to an economic theme Bill Gross considers in his Investment Outlook this month:

Since almost all yields reflect a real plus an inflationary component, it stands to reason that the ability to pay debts expressed in nominal terms should be viewed in a similar fashion when analyzing growth. By so doing one can understand, for instance, why a deflationary environment can be so deadly to a modern-day, debt-ladened economy … the U.S. economy has gravitated to an average nominal growth rate of 5% or so as disinflation has taken hold. Because 5% has become so 'standardized,' government, mortgage, and corporate bond yields have centered around that level as well - the Lehman Aggregate index now yielding approximately 5.30%. 5% is how fast we grow and 5% is what we owe; the two rates are thus symbiotic, one feeding off the other when the economy is in balance. Problems arise however when nominal growth rises …too far below 5% - usually indicative of declining real growth … [Read more here]

Professor Charles Pennington comments:

My comments on George Gilder and his talk at the Junto on Jan 4:

He was very forthright and abject about the many subscribers who started buying his stocks in early 2000. He had lost 94% from peak to trough. He also showed (using data from a third party provider, Mr. Dick Sears) that his stocks had actually outperformed the S&P and Nasdaq from 1996 to present, even including the gigantic decline.

His big idea is kind of paradoxical. He believes that in order to earn big returns, returns much higher than you'd make from bonds, you've got to be in companies that have intrinsically unpredictable future profit streams. The paradox is that he must think that he can at least partially predict them. His aim is to have a few of the companies he owns go up by 100-fold or even 1000 fold, and by doing so, they will make up for the ones that failed. He may be correct, but let there be no confusion–this is not in sync with conventional "efficient market theory," which states that you don't get paid for the "idiosyncratic" component of your risk, the component that can be diversified away.

He does not believe in "reductionism" or "materialism," which is the prevalent idea in science that states that everything is all ultimately explained by the deterministic laws governing microscopic physics. He believes in "emergence" in which new laws emerge as one goes to a larger scale; that quantum electrodynamics is not the relevant thing to think of when approaching something like child psychology. His belief could be either very obvious or very controversial, depending on how it's interpreted. He mentioned an essay that he wrote for the National Review on intelligent design, which unfortunately requires a subscription.

In my opinion, his understanding of science and engineering does not deserve the criticism that he sometimes gets. No one can understand all of science and technology. His thoughts and studies are very wide ranging. He takes in a lot, and he thinks about it clearly and often originally.

Will his strategy be successful over the long term? I don't know. As discussed above, it's been fairly successful since 1996, though few could stomach the volatility. It may be more successful going forward. It might be more orthogonal from the growth/value axis than you might think at first glance. For example, he might do well going forward even if "growth," defined in other ways, does not.

I agree with the Chair that adding a new guy just to monitor PE's or something like that is not promising. That looks like a very rear-view-mirror kind of move. The guy does seem like a bright guy, but individuals can also appear to be misleading themselves about how easy it is to predict things in advance.

Personally, Mr. Gilder is quite a nice guy, very humble and optimistic. He was very gracious and patient with all the questions from the Junto members.



Firstly, John Maynard Keynes in Chapter 12 of The General Theory of Employment, Interest and Money says that:

Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.

I found a reminder of this dictum last week, in fourth down decision-making in the NFL.

[A few years ago David Romer - an economist at UC Berkeley - posted a paper on-line examining the decisions NFL coaches made on fourth down. Romer’s paper found via an examination of expected benefits and costs that NFL coaches were not making optimal decisions. Specifically, NFL teams should be going for it more often on fourth down, rather than to punt or attempt field goals.

… So NFL coaches are told by Romer that it makes more sense to go for it more frequently on fourth down, and the response is that they go for it a bit less often. What explains this reaction?

…the reason why coaches fail to heed Romer’s wisdom is that coaches do not wish to undermine their reputation in the coaching fraternity …]

As my second point, you wrote in Education of a Speculator:

No one doubts that the public must lose at the races in order to pay for the prize money, stable care, employees, and upkeep of the land, building, and equipment … If they bet like other members of the public, they know they’ll lose.


The questions on most multiple-choice standardized tests are arranged roughly according to the number of students who answer them correctly– allowing a casebook example of contrarian thinking. The answers to earlier (easy) questions will be obvious to the crowd (most students); the answers to those later in a section will always be unexpected. In other words, the answers to earlier questions will always be attractive, and those later in each section will always be unattractive.

In the last paragraph of a blog post on Thursday, Steven Levitt noted why in a current competition his optimal strategy is to deviate from the strategy of other participants:

…Knowing the top bettors all pick lots of home underdogs, it means that this week I have no choice but to bet against home underdogs. I need to make sure my picks are as different as possible from the picks of the people in front of me. I gain a lot in dollars if I do much better than the people in front of me. If I do much worse, it doesn’t cost me much.

Similar, behavior optimizes chances of winning an NCAA office pool. In NCAA office pools most people pick the heaviest favorite to win, overlooking how most others pursue the same strategy. The compound probability is what matters, namely the odds of that team winning the tournament as well as the odds of winning the pool when that team wins. Under these conditions, a contrarian approach is often warranted.



 I read a blog post this week that has some good examples of ever-changing cycles (and also displays the availability heuristic). The author of the post describes it as “perfectly rational” behavior to extrapolate from the recent past as a guess for the future.Former Fed. Chairman Alan Greenspan would also endorse the phrasing. In a May 2001 speech he said:

The longer an economy expands at a solid rate, the more people are likely to project that rate forward, eroding previous caution. This is a perfectly rational response. If people were accustomed to a three-year business cycle, they would exhibit far greater caution going into the third year of an expansion than if their normal experiences tended more to ten-year cycles [Read More]



I have been thinking of claques, the group who were hired to go to operas and other theatrical events since time immemorial, and were paid to laugh, cry, and clap. We see them often in the markets, and almost every fixed system, no matter how bad or how out of date, has its group of paid supporters who proclaim how good the results they’ve had from using it are. One finds them amongst groups of noble traders exchanging propaganda on how this book, that system, this personage is a great boon to mankind, and the competitors are the worlds worst.

One sees this behavior in the orchestrated upgrades of brokerage houses, that invariably come after the market has hit a bottom, with their star analyst recommending an increase of 5 percentage points in the stock allocation, and the last remaining weak long position (all too often myself) being extricated from his holdings. One sees it in the news about heavy selling and how the technicals look bad, that often follows the big boys having established a short position in the market. One sees it when this or that eminence goes on television to discuss how he sees imminent Armageddon in the markets unless the agrarians get elected — or how inflation is sure to explode in the next 10 years. One sees it in the threatened actions against anyone who reports that this or that trader has lost billions for his former customers and fund holders. One sees it in the second handers, down and out former stars who disseminate the idea that the market cannot go up to their followers and conservative news men, while the Fed Chairman is establishing his credibility. This is then memorialize with the sending out of a dozen wise men and governors a week to emphasize their vigilance towards and hatred of any inflationary outcropping. One sees it in the interviews of the leading bears that always follows a day when the market drops more than 150 Dow points, and of course in individual stocks — the fund managers who establish a big position in a stock and then modestly allow the media to know that they have been buying it after it goes up more than 5% in a day because of a rising earnings optimism.

My queries are; what are the general principles of claque formation? And what are the economics of the industry, the demand and supply curve of claques, and the relation of the equilibrium points in quantity of claques to increases in uncertainty, past rises or declines, the level of GNP, and the attractiveness of other related occupations like propagandist et al.?

George Zachar adds:

Poking around claque-land, I came upon this crimes of persuasion site, which features a lengthy list of scams.

John De Palma mentions:

A few excerpts that you might enjoy from the 4th chapter (”Social Proof”) in Robert Cialdini’s Influence: The Psychology of Persuasion

Cialindi on claquing:

… the heavy-handed exploitation of the principle of social proof can be traced through the history of one of our most venerable art forms: grand opera. This is the phenomenon called claquing, said to have been begun in 1820 by a pair of Paris opera-house habitués named Sauton and Porcher. These men were more than opera goers, though. They were businessmen whose product was applause …

Cialdini introduces this discussion:

Experiments have found that the use of canned merriment causes an audience to laugh longer and more often when humorous material is presented and to rate the material as funnier. In addition, some evidence indicates that canned laughter is more effective for poor jokes … To discover why canned laughter is so effective, we first need to understand the nature of yet another potent weapon of influence: the principle of social proof. It states that one means we use to determine what is correct is to find out what other people think is correct … In the case of canned laughter, the problem comes when we begin responding to social proof in such a mindless and reflexive fashion that we can be fooled by partial or fake evidence … Our tendency to assume that an action is more correct if others are doing it is exploited in a variety of settings. Bartenders often ’salt’ their tip jars with a few dollar bills at the beginning of the evening to give the impression that tipping with folding money is proper barroom behavior …

And as you did in Chapter 4 of “Practical Speculation,” Cialdini writes on the Keech cult:

Mrs. Keech, though, was the center of attention and activity. Earlier in the year she had begun to receive messages from spiritual beings … The transmissions from the Guardians, always the subjects of of much discussion and interpretation among the group, gained new significance when they began to foretell a great impending disaster- a flood that would begin in the Western Hemisphere and eventually engulf the world … The crucial event occurred sometime during ‘the night of the flood’,’ when it became increasingly clear that the prophecy would not be fulfilled. Oddly, it was not their prior certainty that drove the members to propagate the faith; it was an encroaching sense of uncertainty … So massive was the commitment to their beliefs that no other truth was tolerable. Yet that set of beliefs had just taken a merciless pounding from physical reality: No saucer had landed, no spacemen had knocked, no flood had come, nothing had happened as prophesied. Since the only acceptable form of truth had been undercut by physical proof, there was but one way out of the corner for the group. They had to establish another type or proof for the validity of their beliefs: social proof.



I have a couple thoughts related to your recent writing on the Humor of the Markets … There was an article in The Economist last year on theories of humor:

One description of how laughter is provoked is the incongruity theory … This theory says that all written jokes and many other humorous situations are based on an incongruity — something that is not quite right. In many jokes, the teller sets up the story with this incongruity present and the punch line then resolves it …

With the “incongruity theory” of humor, I’m reminded of something that interest rate analyst James Grant wrote a few years ago in Forbes when he was commenting on how he approaches the markets:

… I look for financial non sequiturs — ideas and prices that apparently make no sense … [The market] is not so efficient that it doesn’t propagate, occasionally, titanic errors and absurdities.

On a separate note, the stadium indicator is being flagged again. A nuclear waste disposer will follow Delta Air Lines as the sponsor of the arena for the Utah Jazz

Gary Rogan adds:

I also believe that success in dealing with the markets and telling jokes is based on the common theme of incongruity. In my opinion though, there are substantial enough differences between the two areas to warrant very different approaches.

Punchline-based jokes rely on the following property of human brain that is becoming better understood with the latest research: people are always predicting the very near future when seeing, hearing, etc. Therefore, perfect timing in telling jokes depends on waiting just long enough for the setup to register and the non-humorous version of the punchline predicted, and then surprising the listener.

Market “jokes” tend to be not jokes at all but fairy tales. They work by suspending disbelief and lulling the “listener” into a false sense of complacency with what starts to seem like a perfectly natural state of affairs. There is no general sense of timing, as the “punchline” is revealed after a fairly unpredictable interval.

While a good sense of incongruity is useful in both areas, dealing with humor involves quick and obvious surprises, and with markets, digging out the non-obvious ones.



Talk of a new stadium for the Oakland A’s:

“In what could evolve into a high-profile branding and technology testing ground for Cisco Systems, the networking giant is reportedly close to handing the Oakland Athletics almost 150 acres of undeveloped land for a new stadium.

…The Chronicle reports that Cisco will likely be a major sponsor and could have its name on the proposed $300 million stadium.

Corporate sponsorship of sporting venues is nothing new, but Cisco seems to be especially keen on leveraging a relationship with the A’s to go beyond simply attaching its name to a building.”

Flashback: “The Wall Street Journal recently documented the inordinate tendency of companies that bought the rights to name stadiums after themselves to fall into bankruptcy, financial difficulties or drastic declines in market value.

…After completing a comprehensive study of every company that named a stadium after itself, beginning with RCA in 1984, we can confirm the gist of the Journal’s article.”



Yesterday’s dramatic finish between Dallas and Washington with a blocked field goal, a run back, a penalty, and another field goal kick to the opposite side, all with six seconds remaining, reminds me of the closes that often happen in markets where until the last moment you’re winning and then a 1 in a billion event occurs to snatch defeat out of the jaws.

Russell Sears replies:

When you are tired, some frustrating and very unexpected things can happen.

This is what makes racing the marathon such a love/hate relationship for me.

You can train and train, be physically ready. When exhaustion hits you, you can out think it, with mental toughness. But you only get a few brief seconds to decide if you really are ready. You must be both physically ready and mentally looking for it. Even then, it can take you by surprise, with a moments mental lapse. Then expect it to turn ugly and the unexpected.

But when you are on, it is powerfully exquisite.

This is a very hard painful lesson to learn and most marathoners, never do. They either give up on the marathon, or give up on doing them for times.

Ask Lance about this.

I suspect when people are on a team, or a large group of speculators, people often rely too much on the others. At that critical moment you are exhausted but needed most. Some will step-up, some will drop the ball.

J. T. Holley responds:

This was felt by Joe Gibbs if you watched the game and heard him speak immediately afterwards. During the Cowboy field goal attempt he had his head up watching his own defeat happen right in front of him, but when Novak (1 for 5 in attempts this year) miraculously got an attempt to win the game in the above mentioned 1 in a billion, coach Gibbs had his head down unable to watch the outcome. Afterwards he simply replied “that doesn’t happen a lot”.

My Hokies had a similar but not the same time frame outcome against Miami on Saturday night. They too blocked a kick that led to their victory. The relevant counting part is something I heard spoken by Coach Frank Beamer some years ago at an alumni function. When questioned in regards to his “Beamer Ball” style i.e. blocked kicks, blocked punt, he — being also the special teams coach utilizing the best athletes on the team instead of reserves — responded with, “one out of every eight plays in a game is a kicking play, that’s where we can make a difference”.

Steve Leslie adds:

In 1999 Jean Van de Velde, France’s greatest golfer of all time, had an opportunity to be the first Frenchman to win the British Open since 1907. He came to the last tee with a three stroke lead, needing only to double bogey the last hole and win the tournament. After hitting the fairway with his driver, Van de Velde hits his next shot far to the right careens of the grandstands and into the rough. He flubs a wedge into the water, takes an unplayable lie, hits his next shot into a bunker, and hits out of the bunker and sinks the putt for an unimaginable seven. He then goes into a four hole playoff where he loses to another improbable winner in Paul Lawrie.

Perhaps the most amazing finish in golf history.

John DePalma replies: calculates “win probability.” These calculations have become popular in baseball. Conditional upon home/visitor status, inning, # of outs, runners on base, and score differential, a team’s probability of winning is derived based upon what has happened historically. For football ProTrade describes “Win Probability” as “a percentage that states a team’s chance of winning at any given point in a game.” The probability reflects “score, clock time, field position, home-field advantage, available timeouts and many other factors.” Before Dallas attempted the field goal with 6 seconds left, the team’s probability of winning was roughly 91%. After the field goal was blocked Dallas’ odds dropped to 43%. The odds fell incrementally to 19% on the runback and penalty. And of course the odds dropped to 0% on Washington’s field goal. (See

As an aside, it’s interesting to note that at least with respect to the baseball calculator, there is no path dependency. Momentum is assumed away. (Momentum and “hot hands” as mostly a statistical illusion.



There was a New York Times article last week headlined, “In ‘97, U.S. Panel Predicted a North Korea Collapse in 5 Years.”

From the NYT article: A team of government and outside experts convened by the Central Intelligence Agency concluded in 1997 that North Korea’s economy was deteriorating so rapidly that the government of Kim Jong-il was likely to collapse within five years, according to declassified documents made public on Thursday.

This forecasting case study makes for a good addendum to Phillip Tetlock’s “Expert Political Judgment” (excerpt from “New Yorker” review below). Tetlock discusses the need for putting beliefs in testable forms, the tendency for statistical models to outperform human judgment, and the bias that motivates black swans to be overlooked.

From the “New Yorker” review: The accuracy of an expert’s predictions actually has an inverse relationship to his or her self-confidence, renown, and, beyond a certain point, depth of knowledge…

Tetlock is a psychologist-he teaches at Berkeley-and his conclusions are based on a long-term study that he began twenty years ago. He picked two hundred and eighty-four people who made their living “commenting or offering advice on political and economic trends,” and he started asking them to assess the probability that various things would or would not come to pass, both in the areas of the world in which they specialized and in areas about which they were not expert. Would there be a nonviolent end to apartheid in South Africa? … Would Canada disintegrate? (Many experts believed that it would, on the ground that Quebec would succeed in seceding.) And so on. By the end of the study, in 2003, the experts had made 82,361 forecasts. Tetlock also asked questions designed to determine how they reached their judgments, how they reacted when their predictions proved to be wrong, how they evaluated new information that did not support their views, and how they assessed the probability that rival theories and predictions were accurate…

Human beings who spend their lives studying the state of the world, in other words, are poorer forecasters than dart-throwing monkeys…

Tetlock also found that specialists are not significantly more reliable than non-specialists in guessing what is going to happen in the region they study. Knowing a little might make someone a more reliable forecaster, but Tetlock found that knowing a lot can actually make a person less reliable … And the more famous the forecaster the more overblown the forecasts…

“Expert Political Judgment” is just one of more than a hundred studies that have pitted experts against statistical or actuarial formulas, and in almost all of those studies the people either do no better than the formulas or do worse…

Tetlock’s experts were also no different from the rest of us when it came to learning from their mistakes. Most people tend to dismiss new information that doesn’t fit with what they already believe. Tetlock found that his experts used a double standard: they were much tougher in assessing the validity of information that undercut their theory than they were in crediting information that supported it. The same deficiency leads liberals to read only The Nation and conservatives to read only National Review. We are not natural falsificationists: we would rather find more reasons for believing what we already believe than look for reasons that we might be wrong. In the terms of Karl Popper’s famous example, to verify our intuition that all swans are white we look for lots more white swans, when what we should really be looking for is one black swan …

[E]xperts routinely misremembered the degree of probability they had assigned to an event after it came to pass. They claimed to have predicted what happened with a higher degree of certainty than, according to the record, they really did. When this was pointed out to them, by Tetlock’s researchers, they sometimes became defensive.

And, like most of us, experts violate a fundamental rule of probabilities by tending to find scenarios with more variables more likely …

[Worse forecasters are] thinkers who ‘know one big thing,’ aggressively extend the explanatory reach of that one big thing into new domains, display bristly impatience with those who ‘do not get it,’ and express considerable confidence that they are already pretty proficient forecasters, at least in the long term. [Better forecasters are] thinkers who know many small things (tricks of their trade), are skeptical of grand schemes, see explanation and prediction not as deductive exercises but rather as exercises in flexible ‘ad hocery’ that require stitching together diverse sources of information, and are rather diffident about their own forecasting prowess.

Tetlock also has an unscientific point to make, which is that “we as a society would be better off if participants in policy debates stated their beliefs in testable forms”-that is, as probabilities-”monitored their forecasting performance, and honored their reputational bets.”>

In the macroeconomic sphere the corollary to Tetlock’s work is this 2002 paper by Yale economist Owen Lamont. Lamont wrote, “[Wall Street forecasts are] not necessarily designed to minimized squared forecast errors; rather, forecasts may be set to optimize profits or wages, credibility, shock value, marketability, political power (in the case of government forecasts), or more generally to minimize some loss function.”

Also, following Greenspan’s Fed Chairmanship, WSJ’s Greg Ip described Greenspan’s approach to policy-making in the context of Tetlock’s book.



From the WSJ last month:

[W]hile Moneyball emphasizes drafting college starters, who have logged substantial innings against quality opposition, Mr. Beane will sometimes violate that advice, especially after agents and rival GMs have gotten in on the secret … A tenet of Moneyball is that on-base percentage is the game's essential offensive stat. So why are the A's seventh in the American League in OBP this year, down from third in 2001? Because other teams have seen Oakland's success and started paying big for players with high OBPs. The A's have instead focused on pure walks, ranking third in the majors in that undervalued category. Similarly, analysts know that pitchers with high strikeout rates hold up well (see Roger Clemens and Randy Johnson). So why does the A's staff rank 12th in the AL with 6.06 strikeouts per nine innings — down from fourth in 2001? Because strikeouts are expensive. So Mr. Beane put a solid infield defense behind his effective but less-than-overpowering pitchers.

(Bacon analogy — "The principle of ever-changing trends works to force quick and drastic changes of results sequences when the public happens to get wise to a winning idea.")

A look at last year's AL West standings gives the impression that the A's lost ground to the Angels … But when Mr. Beane and his analysts looked at P-wins (a predicted winning percentage based on the ratio of runs scored to runs allowed), they saw that both the A's and Angels played like 93-win teams — and realized that better luck would be as likely as reorganization to close the gap.

(Bacon analogy — "Keep out of those switches") From NYT earlier this month:

'The sort of team we put together is probably going to be dissimilar to others,' Beane said. 'When everyone else is zigging, we're going to zag.'

(Bacon– "Copper the public's ideas.") From The Sports Economist last month:

Sauer and Hakes turned to the data and asked if on-base-percentage was truly undervalued in baseball's labor market. Their paper reports that before Moneyball appeared, on-base-percentage was indeed undervalued. After this story became known, though, this advantage disappeared. In sum, baseball executives were able to adjust behavior in light of new information, a result standard economic theory would predict.

From the referenced "Journal of Economic Perspectives" paper:

Michael Lewis's book, Moneyball, is the story of an innovative manager who exploits an inefficiency in baseball's labor market over a prolonged period of time. We evaluate this claim by applying standard econometric procedures to data on player productivity and compensation from 1999 to 2004. These methods support Lewis's argument that the valuation of different skills was inefficient in the early part of this period, and that this was profitably exploited by managers with the ability to generate and interpret statistical knowledge. This knowledge became increasingly dispersed across baseball teams during this period. Consistent with Lewis's story and economic reasoning, the spread of this knowledge is associated with the market correcting the original mis-pricing … The ideas in Moneyball, belying protestations from entrenched interests in the baseball world (Lewis, 2004), spread with sufficient speed that baseball's labor market no longer exhibits the 'Moneyball anomaly.'


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