Monday, November 27, 2006

Probability and Life...

There is a lot of difference between subjective judgement and impersonal probability. And because of the way our brains are "wired", we fail to decipher this difference in real life.

Many a times we take life to be too harsh or unfair to us. Psychological fragility explains our tendency to feel more aggrieved when an event which our non mathematical brain judged as unlikely occurs.

As behaviourial economists have noted, people tend to exaggerate the likelihood of events that are new, emotionally stirring, dramatic, or concrete, and tend to underestimate the probability of events that are old, emotionally neutral, boring, or abstract.

As humans, we use frames of reference and for each and everyone of us, these frames are different. These frames define our "view" of the world. And this is slighly tilted in favour of the right side of our brains. We would rather chat with others than try to figure out the patterns and probabilities around us. Then, there is the fat tail which throws a spanner in a lot of finance based theorems.

For example, all the new finance theories that I was taught were based on the normal distribution curve or the bell curve, but what the Professors did not care to tell me was that the world does not function this way. It is too messy and too complex and very, very inter connected.

Now, I am very lucky that I slept through most of the finance classes. Mark Twain's words come to mind - "I was brilliant, education ruined me"

4 Comments:

Blogger SudS said...

This comment has been removed by a blog administrator.

9:30 AM  
Blogger SudS said...

I thought i'd post my reply here as well ;)

honestly speaking ....
i never try to understand the theories that 'govern' the world or individuals or masses or conversations or financial markets if u must. i agree with u, as for me, these things are too interconnected to yield a theory or a curve without excluding some variables. I subscribe more to the chaos theory, like the butterfly effect if u must.
i believe in a more dynamic assessment of the situations. It kind of worries me that I don't ... patronize a lot of theories . True, they work most of the time. But science says itself that every theory is right till it's proved wrong. There's a lotta electrons oscillating around in this world (uncertainity in short) to fit them in a fail-proof curve.
So while it's necassary to 'know' all the theories who govern which part of my brain i'll use the next time I chat with my professor with the big tits .... it's more important to see if she's looking at ur eyes or not ;).
So in conclusion my friend ... all i'll say about education is that it's like a condom ...
I'd rather have it and not need it ... than need it and not have it ;)
Amen...

9:32 AM  
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8:59 AM  
Blogger Suresh Wadhwani said...

Again good write up... and ur right that most of the finance theories based efficient market hypothesis is crap, like risk return correlation, capm, dcf, etc.

Though i have learned all these theories in last 18 months doing mba... but now ven m left with 2 months of mba m trying to learn the negative sides of these theories.

11:03 AM  

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