Hedging your bets

Posted on November 7, 2010

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Peter: ” It sounds like you’re saying that the more bigoted an  individual or a country becomes  – sort of betting all you have on one horse – the bigger the risk they have of being wrong?”

Jenny: ” Yeah, but if that horse – or long shot bet – wins, they win big. Whereas the ‘experts’ say if your dealing with an unertain future it’s wise to spread your bets . For example purchase mutual funds that include the stocks of many companies, and have many allies or friends in case you need help. One hundred year ago most families prepared for uncertainty by having lotsa kids – some poor countries still rely on this  strategy – because infant mortality was high and the more kids who did survive the more likely some could support the parents in old age.”

Perter: ” But the more bets, or kids, or friends, or alliances you have – the more THINGS you have – the less time and energy you have to  focus resources – you run the risk of spreading yourself too thin, having to keep mending too many fences. You’re damned if you do and you’re damned if you don’t?”
Professoir Wiggly: “Good point. Today the US has to deal with too many local and international problems at the same time,  like the story of the little Dutch boy not having  enough fingers to plug the increasing number of holes in the dyke. Many individuals who have lost their house or their job face the same problem trying to ‘survive’ financially, physically, psychologically – to many problems, too few resources. What’s the solution?”

Peter: “Move back in with your parents.”

Jenny: ” That presumes that your parents still have a house.”

Professor Wiggly: ” Peter’s talking about the situation where the dyke springs a few holes and while plugging them there are still safe places to stand. It’s like the folk wisdom “save for a rainy day.” It depends on how much it rains. As Jenny points out the recent global economic meltdown wiped out a lot of safe ground, furthermore, US citizens aren’t great savers – they occupy low ground – so it doesn’t take much rain to wet their feet, or knees or  crotch. Even when they’ve spread their bets – eg invested in mutual funds – when the improbable happens and whole market crashes they still lose.”

Jenny: “So what’s a person to do? What THINGS should they believe in or have?”

Professor Wiggly: “When facing high uncertainty there’s  no RIGHT answer.  My grandfather used to say: ‘have lots of friends’ – which is another version of ‘spreading your bets’ . But we tend to have friends who share the same beliefs and biases we do, who bet on the same futures.”

Peter: “So are you saying there’s no solution?”

Professor Wiggly: ” I’m saying there’s no completely rational solution. Rational solutions require reliable evidence – and we don’t have reliable evidence about the future – as we’ve discovered. Even when we rely on our most sophisticated models of the economy based on past experience and assumption made by smart people, we can be horribly wrong. So one approach is to rely on semi-rational models – ones that presume that on the basis of past experience we can at least generate reasonable – probable – predictions about the future. Which like predictions of the weather, and prediction of election outcomes all include an estimated amount of error, like the prediction that the outcome will be accurate within three percentage points nineteen times out of twenty. But notice the experts are admitting that at least one time out of twenty the prediction could be way off… like it was in the predictions that failed horribly in the case of the recent recession. The experts advise us to ‘play probabilities’, but remember probabilities are guestimates based on incomplete information. And just because they include precise numbers like ‘right nineteen time out of twenty’ that too is an guestimate- ”

Jenny: ” So the lesson is don’t bet the farm just because some PhD with fancy mathematics tells you it’s a SURE THING?”

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Posted in: Sciencing, Yer Thing