Benford’s Law: Are Euro States and US Stocks Fiddling Their Figures?

Note: the author of the Benford analysis on US stocks has (at least temporarily) recanted: "D'oh, I've discovered an error in my original calculation on Benford's law.  I will post a revised analysis when I'm confident in its accuracy, but in the meantime I'm keeping this post up for the public record only.  The results and conclusions below are not to be trusted."  (http://econerdfood.blogspot.com/2011/10/benfords-law-and-decreasing-reliability.html).  Ahh, the dangers of non-peer reviewed material …

Scary Statistics

As we’ve previously seen, Benford’s law – one of the odder practical truths revealed by statistics – is a great tool for identifying fraudulent accounting, a good indicator that’s there’s something afoot in the footnotes. Now, though, we have a couple of new examples of forensic analysis using the technique, and they don’t make comfortable reading if you’re long of equities; or indeed anything other than sub-automatic weapons and a bricked-up cave.

So on one hand we have evidence suggesting that US corporations are systematically manipulating their accounts, and on the other that the real depth of the issues in the Eurozone are yet to be revealed. If true, we’re a long way from resolution of this particular, and peculiar bust.

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Forensic Finance, Benford’s Way

Misnamed and Mad

One of the more curious statistical anomalies of the universe has turned out to have a range of practical applications in the world of finance. It also turns out to be one of the stranger laws underpinning the stockmarket, although figuring out why is a painful process.

Above all, Benford’s Law can be used to spot financial fraudsters because of a psychological quirk that means we humans are dead useless at pretending to be random. All of this comes from a law that was discovered by one man, explained by another and named after a third. Now that’s random.

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