The authors of “Freakonomics: A Rogue Economist Explores the Hidden Side of Everything” maintain a blog. University of Chicago economist Steven Levitt and New York Times journalist Stephen J. Dubner use statistics to test many social ideas. I found their recent podcast titled “The Folly of Prediction” to be quite interesting, especially as it relates to investing.
The gist of the podcast is something like this:
- Human beings love to predict the future.
- Human beings are not very good at predicting the future.
- Because the incentives to predict are quite imperfect – bad predictions are rarely punished – this situation is unlikely to change.
Here is an excerpt that sums up Levit’s view:
“So, most predictions we remember are ones which were fabulously, wildly unexpected and then came true. Now, the person who makes that prediction has a strong incentive to remind everyone that they made that crazy prediction which came true. If you look at all the people, the economists, who talked about the financial crisis ahead of time, those guys harp on it constantly. “I was right, I was right, I was right.” But if you’re wrong, there’s no person on the other side of the transaction who draws any real benefit from embarrassing you by bring up the bad prediction over and over. So there’s nobody who has a strong incentive, usually, to go back and say, Here’s the list of the 118 predictions that were false. … And without any sort of market mechanism or incentive for keeping the prediction makers honest, there’s lots of incentive to go out and to make these wild predictions”
They propose a rather ingenious solution. They propose that financial pundits should have their “batting average” published with each article. This is a way readers would have a better idea of the past success of the author’s predictions. I’m not holding my breath in anticipation of this proposal actually happening. I will continue to read predictions of the future with healthy skepticism.
Find the podcast here.