No one seems to remember the second part of Occam’s razor as rumored1 to be stated by Albert Einstein: “Everything should be made as simple as possible, but not simpler.”

That is an issue I am encountering quite frequently these days. We see it in discussions about markets, politics, sports, economics, indeed, just about any field where questions of an unknown future drive debate. This morning, I want to briefly discuss the issue, pointing out a few recent examples. My advice is to be wary whenever you see this approach.

First, let’s understand what Occam’s Razor actually means: When we select among competing explanations for any given unknown, we prefer that which offers the simplest explanation of any effect. This includes that which makes the fewest assumptions, and requires the least logical contortions. However, one should proceed to simpler theories until simplicity can be traded for greater explanatory power. This is especially true when it comes to explaining complex events with lots of moving parts.

Consider the following statements:

Politics: No modern president has ever won a second term when the unemployment figure was 7.3% or more.2

Markets: The average Bull Market lasts 31 months.3

Sports: The new line up of (Choose: NY Knicks Jeremy Lin/Carmelo Anthony or NY Jets Mark Sanchez/Tim Tebow) locker room disruption.

Credit Crisis: High levels of leverage existed prior to the crisis without incident.4

Apple (2004-10): Has a very high P/E.

Affordable Housing Policies: Allowed lower income people to purchase homes they could not afford.

Note that I did not include any conclusion based upon these single variable analyses. But these are the simple, recognizable memes circulating the intertubes. They lay traps for the unwary. The conclusions the authors of these draw are:

1. The incumbent will lose in November
2.Sell your stocks
3. The Knicks and Jets cannot win a playoff
4. Leverage was not a factor in the credit crisis
5. Don’t Buy Apple
6. It was all Barney Frank’s fault

These are all probability questions. When doing these analyses, we do not know what the future outcome will be. Certitude in the face of probable outcomes is discouraged, as is gross over-simplification.

I have addressed many of these over the years (I want to get to the leverage issue soon).

Some people work backwards: They start with their conclusion, than set about hunting for any data that supports it. This is the worst form of confirmation bias. The preferred method is to research all of the relevant data, and see what conclusion that leads you to.

Bottom line: When it comes to investing, the errors of single variable analyses, oversimplification and bias all can be very expensive. Recognize these flaws when you encounter them in any sort of commentary, and adjust your expectations accordingly.

>

Previously:
Single vs. Multiple Variable Analysis in Market Forecasts (May 4th, 2005)

Hume, Causation & Science (January 14th, 2012)

______________________

1. Provenance: There is some question as to the whether Einstein actually said this, according to (Quote Investigator)

2. Unemployment rate by year (BLS)

3. This Bull Market Is Hard to Pin Down (NYT)

4. Bethany McLean: The meltdown explanation that melts away (Reuters)

Category: Apprenticed Investor, Investing, Markets, Mathematics, Philosophy, Politics, Psychology

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

15 Responses to “Complexity, Context, Probability & Bias”

  1. cognos says:

    I got you.

    Except for “Apple has a very high P/E”.

    Don’t you mean “very low P/E”?

    Its only about 15x. It was a great buy back in the early 2000s with 100 PE and 60 PE.

    ;)

    ~~~
    BR: note the dates — Apple’s P/E was much higher 5 years ago

  2. Casual_Observer says:

    Something else I might point out. Occam’s Razor tends to be more useful for arriving at explanations of events that have already occurred but whose cause is not yet known. Doctors, for example, use it every day. A patient presents with symptoms of fatigue, body and head ache, and congestion. It could be a rare disease or a breakdown of the patient’s immune system due to some cause. However, Occam’s Razor suggests that it’s most likely a virus that is making the rounds. Hence, doctors go for the simple answer first (which statistically is almost always right) rather than hospitalizing the patient for cancer. Occam’s Razor is much less useful as a predictor of future events. Not useless, but less useful.

  3. Rightline says:

    “Some people work backwards: They start with their conclusion, than set about hunting for any data that supports it. This is the worst form of confirmation bias. ”

    Why you be talkin’ ’bout KD and Mish like that?

  4. gordo365 says:

    In politics – I apply William of Ockham’s razor to find cause of results of last midterm election. Simple explanation – when the economy sucks, lots of incumbents lose. Republican’s rejected this simple interpretation of the cause of their swelling ranks in the house, and instead assigned cause to support for idealistic obstructionist ideas.

  5. darth beta says:

    Actually the statements are seen through the authors filters. Perspective is amazing! For example the word “high” is opinion based on the authors filters. The correct factual statement would have been something like:

    Credit Crisis: High levels of leverage existed prior to the crisis without incident.4
    level of XX% existed prior…..

    Apple (2004-10): Has a very high P/E.
    Apple has a P/E of XX

    Affordable Housing Policies: Allowed lower income people to purchase homes they could not afford.
    Housing priced in the range of XX-XX allowed people with income of XX

    Your example falls apart because there is opinion buried within each statement. What your asking is that people hear words like “high” and not judge that as a bad thing. Which comes downs to the readers (hearers) filter. Some hear high and think good, others think bad. More than an example of stats this is an example of poor communication.

    ~~~

    BR: I had a felling someone was going to make that claim, and misinterpret my language. “High” and “Low” are value neutral descriptors. If you want to reflect an opinion, one would write TOO HIGH or EXTREMELY LOW. There is a difference between the two.

    As to the Credit Crisis, if you read the article referenced by footnote, you will see the language comes straight from that author.

  6. 10x25mm says:

    In economics, everything seems to be multivariate. Because there are at least two sides to every transaction?

  7. AHodge says:

    economists popularized this maybe 40 years ago.
    and used it to support completely whacko simplist theories like monetarism
    einstein skewers it, everything we think and do in these areas is at some major level of abstaction.
    i find it useless to choose how much and what?

  8. Meegan says:

    Thanks, appreciate the insight

    You are a philosopher mathematician, aren’t you?

  9. AHodge says:

    complexity is not always wrong
    the world is complex
    an 800 behavioral equation forecasting model is a tool
    in my experience better than you winging it with a paper and pencil.
    at least you will have accounted for “everything” when you miss a little or a lot
    far better than a monetarist forecasting everything on money supply
    complexity does however leave massive play for stupid humans
    confusing themselves
    getting parts wrong
    or losing track of causality

  10. darth beta says:

    “High” and “Low” are value neutral descriptors.- Yes but they are relative terms. And more importantly our relative base lines are not the same!
    Better to speak/write in absolutes.

  11. AHodge says:

    dear darth
    while i dont agree with Barry that high and low are clear
    your argument falls apart because as BR says they start with an imprecise one shot idea however defined. but end up with completely fixed conclusions. You remind me of my stay at WR Grace where you were not allowed to use any adjectives or adverbs. Just the numbers. this did not produce or assure brilliance.

  12. AHodge says:

    and just to be clear Einstein only added the “but not Simpler” as
    i think
    mostly a playful refutation.
    his E=MC squared was simple
    its a start
    but you cant build an Abomb out of that

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