Category Archives: Start Here

How to do Precisely the Right Thing at all Possible Times

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I recently added another Danny Kahneman page to the site and in that page is a link to a talk Dan Gilbert gave at SXSW 2006 entitled “How to do Precisely the Right Thing at all Possible Times”. Dan was only being a little bit facetious because right at the beginning of the talk he tells you how to do exactly that. “The happiness you can expect from anything you do is a function of two things: the odds of getting a gain, and; the value of that gain. You multiply these two things together and you know exactly how good your decision or action is going to be.” Sound familiar? Very similar to what NNT is saying (I’ve heard him talk about it in numerous talks, but this comes from his Long Now talk) when he says, “The telescope problem… what matters is not the probability, what matters is the event, so if I have a small probability of losing a million dollars, I don’t care about the probability I care how much I lose. You worry more if you have a small probability of being on a plane that crashes than if you have a small probability of not having an umbrella in the rain. So it’s not the probabilities that you care about, It’s the probability times the event, the magnitude of the event.” Dan is talking about the possible gain and NNT about loss, but the equation is the same, is it not?

Dan’s talk goes on to point out that because of how we’re wired we are actually pretty much clueless about determining the value of a gain that occurs in the future. So, while the equation is valid it’s not very useful because it’s basically impossible to know the extent to which we will value something that hasn’t happened- that isn’t happening right now! I suppose the same could be said for loss, and in fact Dan addresses this in his talk, pointing out that however grand the misfortune that befalls us, after about a year we’re back to our own personal happiness equilibrium.  I listen to this talk about once a month. In fact it’s what inspired my adventure into heuristics which lead to Danny Kahneman and NNT.
Check it out How to do Precisely the Right Thing at all Possible Times.

Daniel Kahneman – A Bat and a Ball Cost $1.10

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Daniel KahnemanRIP Danny. Thank you for your insights and stories. I’m glad of the opportunity to know your work. You made a difference.

[Update 9/8/2010 A paper Danny co-authored, “Income’s Influence on Happiness” has just been released.]

… the bat costs $1 more than the ball. How much does the ball cost? Daniel Kahneman KNOWS that the first thought that entered your head was $.10–even if you’re a Computer Science major at MIT. But that’s the wrong answer.

Daniel Gilbert’s “Stumbling On Happiness” led me to Nicholas Taleb’s “Fooled By Randomness“. Both books cite the work of Danny Kahneman. I blogged a bit about him here. I have been rummaging around the internet looking for whatever I can find on Danny and his work and have come up with some excellent content. But let me give you a taste of the sort of fascinating facts you’ll hear in Danny’s lectures first.

In a study Danny (I don’t know him personally but after listening to all these lectures, I feel as though I do. He could no doubt name the cognitive bias this suggests) mentions in one of his talks, people are asked how much pleasure they derive from their car. They are then asked enough questions about the car to determine its blue book (resale) value. It turns out that there IS a correlation between the amount of pleasure the subject reported and the dollar value of the car. i.e. Yes, that late model BMW in the garage DOES give you more pleasure than my 20 year old Honda would. BUT! They then go on to ask the subject if they find their commute to work pleasurable, and guess what?– nobody does!. It turns out that the ONLY time people derive pleasure from their car is when they are THINKING about it.

From Wikipedia:
With Amos Tversky (Kahneman’s longtime research partner, with whom he would have shared the Nobel prize had Tversky not died in 1996) and others, Kahneman established a cognitive basis for common human errors using heuristics and biases (Kahneman & Tversky, 1973, Kahneman, Slovic & Tversky, 1982), and developed Prospect theory (Kahneman & Tversky, 1979). He was awarded the 2002 the Nobel Prize in Economics for his work in Prospect theory.

Major Contributions:

  • anchoring and adjustment -describes the common human tendency to rely too heavily, or “anchor,” on one trait or piece of information when making decisions.
  • availability heuristic -where people base their prediction of the frequency of an event or the proportion within a population based on how easily an example can be brought to mind.
  • conjunction fallacy -when it is assumed that specific conditions are more probable than a general condition that contains the specific condition. (i.e. You think you’re MORE likely to die in an air disaster brought on by a terrorist event, than you are to die in ANY kind of air disaster).
  • framing (economics) -reversals of preference when the same problem is presented in different ways. (10% fat vs. 90% fat-free!)
  • loss aversion -the tendency for people strongly to prefer avoiding losses than acquiring gains. (Why New Yorkers stay in New York for the culture, and Angelenos stay in LA for the weather!!).
  • peak-end rule – we judge our past experiences almost entirely on how they were at their peak (pleasant or unpleasant) and how they ended.
  • prospect theory -how people make choices in situations where they have to decide between alternatives that involve risk.
  • reference class forecasting -predicts the outcome of a planned action based on actual outcomes in a reference class of similar actions.
  • simulation heuristic – people determine the likelihood of an event based on how easy it is to picture mentally. (Why we buy lottery tickets.)
  • status quo bias -in other words, people like things to stay relatively the same.

Media – Most of these lectures have a fairly long-winded intro. Skip ahead if you don’t need the background info.

Explorations of the Mind – Well-Being: Living and Thinking About It. (YouTube)

Conversation With History – Intuition and Rationality. (YouTube)

Conversation With History – Intuition and Rationality. (Audio)

Explorations of the Mind – Intuition: The Marvels and the Flaws. (YouTube)

Nobel Prize Lecture. (YouTube)

Update March 2009- Kahneman and Taleb on the same stage discus the crash. (YouTube)

Update March 2010. From the February 2010, Ted Talk Daniel Kahneman: The riddle of experience vs. memory. (YouTube)

Found a few more DK links.
A Perspective on Judgment and Choice 24pg. PDF doc. on the subject of his Nobel Prize.
The Allais Paradox Wired magazine 10/10 (Archive)

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EconTalk – Taleb on Black Swans (2007)

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Don’t know how I missed having this in here. NNT lists this as one of his favorite interviews as well.
From the highly addictive and always excellent EconTalk.org. (iTunes subsrciption link here. 2007 2008)

Nassim Taleb talks about the challenges of coping with uncertainty, predicting events, and understanding history. This wide-ranging conversation looks at investment, health, history and other areas where data play a key role. Taleb, the author of Fooled By Randomness and The Black Swan, imagines two countries, Mediocristan and Extremistan where the ability to understand the past and predict the future is radically different. In Mediocristan, events are generated by a underlying random process that is normally distributed. These events are often physical and observable and they tend to cluster around the middle. Most people are near the average height and no adult is more than nine feet tall. But in Extremistan, the right-hand tail of events is thick and long and the outlier, the seemingly wildly unlikely event is more common than our experience with Mediocristan would indicate. Bill Gates is more than a little wealthier than the average. The civil war in Lebabon or the events of 9/11 were more worse than just a typical bad day in the Beirut or New York City. Taleb’s contention is that we often bring our intuition from Mediocristan for the events of Extremistan, leading us to error. The result is a tendency to be blind-sided by the unexpected.

Play

Taleb Outsells Greenspan as Black Swan Gives Worst Turbulence – Bloomberg.com

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Shared by Woolwit

This is an older article but has some great biographic info and also explains (to me anyway, a complete non-trader) what Taleb means when he says out-of-the-money.

On a freezing day in March 2007,
Nassim Taleb walked into a conference room at Morgan Stanley’s
Manhattan offices on 47th Street and Broadway to address a group
of the firm’s risk managers. His message: Your models don’t
work.

`He Cleaned Up’

On Oct. 19, 1987, he was sitting at a row of desks on First Boston’s trading floor at Park Avenue Plaza in Manhattan when his dream came true. The Dow Jones Industrial Average plummeted 22.6 percent in the biggest one-day drop in U.S. stock market history. The crash caused Eurodollar futures to surge after the U.S. Federal Reserve pumped liquidity into the banking system, lowering interbank borrowing rates. Taleb’s positions exploded once again.

“We all knew that he did well, that he cleaned up on that and made $35 million to $40 million,” Diakolios says of the sum the bank made on Taleb’s positions. “The equities guys below us thought, ‘Why did some guy upstairs make all this money on a day when everybody got killed?”

‘ The payday for Taleb was big. Without divulging the amount, he says 97 percent of the money he’s ever made was on Black Monday in 1987. `

`There are concentrated pockets of luck,” he says.

Nassim Nicholas Taleb – The Future Ain’t What It Used To Be

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Nassim Nicholas TalebIf you want to be a dentist, it’s rational to assume that if you go to school, get your degree, and set up a dental practice, you will be able to attain a comfortable standard of living. You may be able to project your probable income range with some degree of accuracy.
But if you want to be a rock star, it’s irrational to assume that if you go to rock school, get good at guitar, and start a band, you will become rich and famous.
According to Nassim Nicholas Taleb’s way of thinking, the dentist and the wannabe rock star fall into two distinct categories with drastically different risk characteristics. The dentist falls into the domain he calls ‘Mediocristan’, and the rock star, ‘Extremistan’. Extremistan is dominated by ‘fat tails’, or rare but profoundly significant events. Problems arise when we think we’re operating in Mediocristan but in fact are operating in Extremistan.
“Karl Marx wanted to turn knowledge into action, what I want to do is turn our lack of knowledge into action”. Taleb suggests that by becoming aware of our own ignorance, we can stop taking action where our action is irrational.
I’m on my second reading of Fooled By Randomness and am very much looking forward to The Black Swan. In the meantime I’ve been hunting down all the audio I can find on Taleb because his talks are extremely interesting and he is a very engaging speaker. He has a bit of attitude when addressing an audience, in part no doubt because much of what he has to say offends of lot of people, especially anyone whose expertise is related to forecasting. He has obvious disdain for financial forecasters in particular, probably because he sees the impact these ‘guys in suits riding around in limousines’ have on the lives of ‘people taking the subway to work everyday’ (i.e.pensions).
What Taleb has to say has resonated with me at a very deep level. Much of the facts and studies he brings to light confirm my long lingering suspicion that something about the way the world sees itself is profoundly inaccurate and weirdly irrational.
I’ve listened to each of these talks at least a half dozen times and every time I do I take away another profound insight. Be sure to check out Taleb’s Home Page as well.
Taleb on EconTalk.org April 30, 2007
LongNow Lecture-The Future Has Always Been Crazier Than We Thought Feb. 4, 2007