Bamboozled By Your Bias Blind Spot

No UFOs Here

It has come to our attention that there are amongst you those who are quite happy to accept that behavioral biases affect the way that other investors act but refuse to agree that you, yourself are so afflicted. Of course, most UFO abductees reckon everyone else is a faker, so we shouldn’t be too surprised at this.

There’s a term for this wilful foolishness: it’s called the bias blind spot. We recognise it in others, so why don’t we see it in ourselves?

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Forecasting A Financial Earthquake

Guru-nomics

It’s that time of year when every self-respecting student of markets blows the dust off their crystal ball, and sets about attempting to forecast the direction of markets for the next year. Some pore over charts, others examine the history of presidential election years, some analyse market data and others, surprisingly large numbers of others, consult star charts.

Financial forecasters suffer from the same problems as earthquake forecasters – they don’t understand the underlying principles of what they’re trying to analyse. While the latter generally recognise this and have the sense to put in place the appropriate caveats the former mainly seem to be blind to the possibility of error. Of course, the fact that over-confident earthquake analysts may lose their careers and reputations while their equivalent in finance will merely have to wait another year to assay an attempt at guru status may have something to do with this.

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Bah, Humbug … The Value of a Child’s Gift

Adulthood

One of the neat things about economics is that it provides different ways of thinking about problems. Take adulthood for instance. This, you might think, is a vague concept which has something to do with children no longer borrowing money from you and not giving it back. Or even leaving home and not returning. An economist, though, sees it differently: adulthood is the moment your child’s spending on Christmas gifts exceeds the value of those they receive. Bah, humbug.

The creep of economics out of its natural domains, finance and resource management, into other areas has a name: economic imperialism. This creep has supposedly been going on for a long time, and has happened so insidiously that it’s been hard to spot. Yet given that we all know that economics is less a science than an invocation of the dark arts of the necromancer this isn’t necessarily a good thing. Maybe, though, this points us in the direction of some overdue reforms of markets, shareholder rights and, perhaps, even capitalism itself.

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HONTI #6: Distrust the Experts

Rule #6: Don't take experts at face value: check their knowledge and their results.

Trust Needs To Be Earned, Not Assumed

In a complex world we often have no choice but to rely on experts to help guide us. If we’re going to lean on such people, though, we really ought to make sure that they know what they’re talking about. This is certainly true for financial experts, but is equally true in other areas as well: relying on the first medical opinion you get isn’t generally a smart move, either.

It seems there are certain areas in which we actually default to trusting our advisors rather than distrusting them – doctors, teachers, attorneys and so on.  Often this trust is justified, but sometimes it isn't – and when this happens we lose out. It turns out that a default of not trusting our advisors is the safest approach, even if that feels ethically dubious¹. We are, on the whole, inclined to trust people, but mistaking an advisor for a friend is a risky strategy.

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When Incentives Go Bad

Strings Attached: Untangling the Ethics of Incentives by Ruth W. Grant

Way back in ’76, when heels were high, flares were wide and hair was long (for the men, at least) a couple of dudes called Michael Jensen and William Meckling proposed a solution to a problem that had vexed even the founders of economics. They attempted to resolve a puzzle that started with Adam Smith and which has ended in the crash to end all crashes; and as ever we’re looking at a set of consequences which was unforeseeable in advance but seems inevitable in retrospect.

The problem was how do you align the interests of the owners of corporations – the shareholders – with those of the managers of the companies? The solution was ingenious, but the chain of events it set off has exposed the nature of the concept of incentives. Because, it turns out, incentives are not neutral economic things, but strike at the very heart of what it means to be human.

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Europe, Taxed by Tobin

1808 and All That

The soap opera that is the Eurozone continues unabated, as the intransigence of the UK has caused a split that seems likely to cleave the European Union in two. Regardless of the rights or wrongs of the situation the British appear to have approached the negotiations over Europe’s finances with the finesse of a bulldozer and the subtlety of a sledgehammer.

The UK has calculated that agreeing to the latest half-baked plan to save the Euro, which they’re not part of, is not in their national interest. As this “national interest” appears to be that of the UK’s financial sector, which helped caused most of the problems in the first place, this looks a bit strange. What’s even more strange is the main issue is the imposition of a so-called Tobin tax on financial transactions: which is peculiar mainly because the British already have such a thing and have had it since 1808.

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Get Rich, Flee Temptation

Double Your Salary

Let’s say you were made an offer in return for giving up your favourite treat for a month: let’s say you were told you would double your monthly salary - forever - if you abstain from alcohol or coffee or heroin or whatever for just four weeks. Would you take this deal?

It’s a no-brainer, of course, which is why it’s exceedingly odd to discover that this exact deal is one that many of us are unable to make. Human lack of self control is a remarkable thing, but it’s made many times worse by financial services offers designed to lead us into temptation.

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Losing Momentum: Is It Time to Exploit Mean Reversion?

One Last Free Lunch

There are a range of so-called anomalies that have preoccupied investors for many years, largely because they seem to offer a free lunch, which is a rare thing in investment markets. So the momentum effect and various value-related effects have spawned a whole host of exciting but not entirely convincing ventures.

A range of recent research now threatens to actually shed some light onto these anomalies suggesting that the momentum effect has vanished and that value effects are real but caused by idiosyncratic factors. It also suggests that mean reversion, upon which many investing careers is based, generally works but sometimes only if you have an investing lifetime to wait. On a positive note, NOW might be a really good time to try and exploit it.

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