Tuesday, September 11, 2012

Finding the Future

Browsing the web this morning I came across a pair of articles that speak significantly to one another and illustrate a general problem with forecasts of the future.

In Apologia Pro Vita Sua, Emanuel Derman reflects on life as a "financial engineer" who worked in investment banking and built financial models designed to quantify a "vast and ill-understood sea of ephemeral human passions." Two points from the article are worthy of note. First, the concept of financial engineering is hugely flawed. Engineering models, for example of the structural tensions on a bridge, involve a set of deterministic factors for which one can calculate precise answers. The notion that one can directly port such deterministic mathematical models to finance is, as noted by many subsequent to the crash, a bit of hubris. As Weber noted oh so long ago, the causes of social action differ from those found in the natural world. This underpins the second key point in the article:  the models work well when the sea stays calm, but not when a storm hits

In Trending Upward, Michael Horowitz and Philip Tetlock explore ways the intelligence community can better see into the future. Based on an analysis of the National Intelligence Community Global Trends Reports, they note a similar pattern. The reports almost inevitably fall into the trap of treating the conventional wisdom of the present as the blueprint for the future 15 to 20 years down the road. Thus, many of the things the reports get right were already unfolding when the report was written and the reports have struggled to make accurate non-obvious predictions of big-picture trends.  The article goes on to suggest a number of specific ways that analysts might improve their predictions. Interestingly, the suggestions largely involve various ways to quantify the process. Unlike financial engineering, which builds quantitative models of the economy itself, Horowitz and Tetlock eschew attempts to model the political future directly. Instead, they suggest various means to quantify the process of making and aggregating expert judgments about the future.

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