Behavioral psychology in the marketplace; Daniel Kahneman says “noise” is wrecking our judgment

Different economic forecasters will be noisy. A year later, there will be a correct answer. That’s when you can determine bias—whether [each forecaster] generally overestimated or underestimated the information. You don’t have to wait a year to observe noise.

Daniel Kahneman Says Noise Is Wrecking Your Judgment. Here’s Why, and What to Do About It. Barron’s, May 28th

Note to reader: we discussed Mr. Kahneman’s groundbreaking research in the past.  Specifically, his Nobel prize-winning research helped refine the study of behavioral economics and the concept of the  rationally irrational consumer. While we all are handicapped with unconscious preexisting biases, the vast sea of humanity is not aware that they exist, so we must make an effort to overcome them. If we can, we should be able to formulate more accurate economic and financial market predictions. If you a regular reader of my blog, you know that I have always emphasized that any macroeconomist or market prognosticator who refuses to recognize the agenda and objectives of the new world order must be heavily discounted. However, if we recognize this collective willed ignorance, we gain an edge over many well regarded economists and analysts.

As an independent economics researcher, I attempt to formulate my economic theories and financial research independently of all the omnipresent “noise,” which is why my research is often unique. To lower the noise in my predictions and determinations, I find it vital that I formulate my thoughts first, before I am “contaminated” by ideas of others; even if they are considered experts. This is why I often am not aware of what other analysts in the media are saying

In this Barron’s interview, Mr. Kahneman emphasizes that researchers who are making judgements, observations, and measurements should be making them independent of other researchers. When we put people in a room and ask them to generate a group judgement, we lose a lot of insightful information. He says that the best way to run a meeting is for individuals to come prepared with their individual judgements, and then start a discussion. If we start a discussion without eliciting prior judgements or by possessing preconceived ideas from the outside, people are going to unduly influence each other.

Barron’s: You say that errors in judgment have two main components, bias and noise. Let’s start there.

Daniel Kahneman: When judgements have a correct answer, bias is the average error. Noise is the variability of the error. It’s that simple. And even when you don’t know the correct answer, you can still observe noise…

The economy and markets work on differences of opinion; you can’t consider it a bad thing. Diversification is not noise. Noise is unwanted variability; it is variability in judgements that should be identical. Federal judges are supposed to be interchangeable. Similarly, when you have an investment firm, and you assign Smith or Kagen to assess a particular investment, you don’t want sources of noise to be a factor. You shouldn’t care whether it’s Smith or Kagen making the evaluation.

Daniel Kahneman Says Noise Is Wrecking Your Judgment. Here’s Why, and What to Do About It. Barron’s, May 28th

Daniel Kahneman Says Noise Is Wrecking Your Judgment
Insurance company premiums vulnerable to noise

Mr. Kahneman provided Barron’s with an example of noise; he was hired as a consultant for an insurance company as it wanted help in determining the right premiums for its products. The insurance firm constructed cases and submitted them to 48 underwriters.

The question was, how much variability, or noise, was there among underwriters? It turned out to be 55%—not the 10% they expected. Even Mr. Kahneman was surprised. The organization was completely unaware they had this problem. Noise was not on their radar. Variability is very costly, even if your premiums are correct, on average. A premium that’s too high will cause the insurer to lose business, and a premium that’s too low leaves money on the table. The insurer was losing hundreds of millions a year because of variability in its premiums.

Anyone who has been a long-term property manager and landlord can relate to this problem. In my walk as a property manager, I am often confronted with wide variabilities in P&C insurance premiums for the same coverage, and from the same firm.

Types of noise

Mr. Kahneman distinguishes three types of noise;

Level noise: The easiest example is judges passing sentences. Some judges are more severe than other judges would rule on the same cases. That’s level noise.

Occasion noise: Another source of variability is how one judge’s decisions might change during different mental states, or from hearing a case in the morning versus the afternoon. We call that occasion noise.

Pattern noise: Probably the most important source of variability is that people just see the world differently—that’s pattern noise. Judges view different criminals differently. One of them would be more severe in case A, and the other would be more severe in case B. We are not aware of it, because we can’t look inside people’s heads. We hire judges, so that they can be interchangeable, but the realities belie this objective.

How to overcome biases and noise

We need to resist relying on our intuition, which is just the feeling we “know” something even if we are not sure why you know. Our challenge is to identify unwanted variability or noise and then do something to mitigate it. This is where independent and unbiased research proves vital.

Most economists mentioned in the MSM and alt-media have proven almost useless, as they are beholden to the system for their paychecks and will thus refuse to contemplate the concepts we freely discuss on this blog. The worst algorithm we can employ is for us to embrace our worldview while simultaneously regarding these macroeconomists as knowledgeable experts.

In some cases intuition is very useful for making instant decisions. In other, less time-critical situations, Kahneman says judgements based on intuitive feelings need to be disciplined and delayed.

Mr. Kahneman emphasizes that we should act on intuition only after we have made a balanced and careful consideration of all the evidence. This means that we must gather evidence from diverse sources, and from people who have made their own independent judgement of the evidence. Don’t rely on the groupthink of any source, especially the MSM and compromised alt-financial media. Without this disciplined attitude, Kahneman said, noise can easily be amplified.

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3 thoughts on “Behavioral psychology in the marketplace; Daniel Kahneman says “noise” is wrecking our judgment

  1. So Kahneman has made a career of ‘discovering’ people are not robots, despite Cass Sunstein’s wish, and those like him, to the contrary. Thanks, Captains Obvious.

  2. This is a Signal to noise ratio issue. The Math / Science. When signals are a measure of amplitude, in measures such as volts (V) or amperes (A), the formula for Signal to Noise Ratio is:

    SNR = 20 * log 10 (S/N)

    It’s a logarithm function so for any signal to be picked up out of the background milieu it must be orders of magnitude stronger. This is why leading indicators so valued in economic anslysis. If it’s valued than it’s likely the target of manipulation in this system. Which again sends analysts searching for more subtle indicators in the noise. A famous one is The Lipstick Indicator which suggests that rising sales of lipstick are an indicator of troubled times. I think it has been discredited generally. But it underlines the greater issue of looking farther and farther down the rabbit hole for valid signal.

    1. Re: Signal to noise ratios and bias, musical sound and inherant subjectivites,

      I prefer the sound of my old school tube amplifier. It’s clunky and awkward with mechanical knobs and switches all over the place. When powered up, one can feel the electricity flowing through it. Real physical vibrations with little pings and pops all over the place. When heated-up, it becomes Grandma’s kitchen, warm and cozy. However, like the little-engine-that-could, it struggles to accommodate the dynamic musical peaks but the reward is the softer music which becomes harmonic heaven. Open with soul. Musically, it casts a wide net, more importantly, it’s alive and touching. Maybe not the whole truth in sound but a sincere effort.

      As opposed to my streamlined 1000 watt solid state amp which has laser-like accuracy, focus and punchy bass, however it’s unquestioning, cold and analytical. It forces musical truth upon the listener, like a mix of over-powered stormtrooper and scientist in a bottle.

      Most people that listen to my sound system prefer the solid state amp over the tube. Why? The solid state is louder and, of course, who can’t resist punchy bass.

      My point? Big Media establishment is solid state.

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