Posted tagged ‘Rationality’

Risk Intelligence IV

March 20, 2019

Overcoming Biases

In a recent post, RISKVIEWS proposed that Risk Intelligence would overcome biases.  Here are some specifics…


  • Anchoring – too much reliance on first experience
  • Availability – overestimate likelihood of events that readily come to mind
  • Confirmation Bias – look for information that confirms bias
  • Endowment effect – overvalue what you already have
  • Framing effect – conclusion depends on how the question is phrased
  • Gambler’s Fallacy – Belief that future probabilities are impacted by past experience – reversion to mean
  • Hindsight bias – things seem to be predictable after they happen
  • Illusion of control – overestimate degree of control over events
  • Overconfidence – believe own answers are more correct
  • Status Quo bias – Expect things to stay the same
  • Survivorship bias – only look at the people who finished a process, not all who started
  • Ostrich Effect – Ignore negative information

Each of Education, Experience and Analysis should reduce all of these.

Experience should provide the feedback that most of these ideas are simply wrong.  The original work that started to identify these biases followed the standard psychology approach of excluding anyone with experience and would also prohibit anyone from trying any of the questions a second time.  So learning to identify and avoid these biases through experience has had limited testing.

Education for a risk manager should simply mention all of these biases directly and their adverse consequences.  Many risk managers receiving that education will ever after seek to avoid making those mistakes.

But some will be blinded by the perceptual biases and therefore resist abandoning their gut feel that actually follows the biases.

Analysis may provide the information to convince  some of these remaining holdouts.  Analysis, if done correctly, will follow the logic of economic rationality which is the metric that we used to identify the wrong decisions that were eventually aggregated as biases.

So there may still be some people who even in the face of:

  • Experience of less than optimal outcomes
  • Education that provides discussion and examples of the adverse impact of decision-making based upon the biases.
  • Analysis that provides numerical back-up for unbiased decision making

Will still want to trust their own gut to make decisions regarding risk.

You can probably weed out those folks in hiring.

Risk Intelligence II

February 28, 2019

Somehow it worked.

Several psychologists stated that economists were rational and those who didn’t know what economists knew were irrational.

They collected data on how irrational folks are and analyzed that data and grouped it and gave cute names to various groups.

But I think that you could do the same thing with long division. Certainly with calculus. Compare answers of rubes on the sidewalk to math PhD s on a bunch of math questions and how well do you think the rubes would do?

Some of the questions that the psychologists asked were about risk. They proved that folks who rely solely on their gut to make decisions about risk were not very good at it.

I am sure that no-one with any Risk Intelligence would have bet against that finding.

Because Risk Intelligence consists of more than just trusting your gut. It also requires education regarding the best practices for risk management and risk assessment along with stories of how well (and sometimes ill) intentioned business managers went wrong with risk. It also requires careful analysis. Often statistical analysis. Analysis that is usually not particularly intuitive even with experience.

But Risk Intelligence still needs a well developed gut. Because history doesn’t repeat, analysis always requires simplification and assumptions to fill out a model where data is insufficient.

Only with all of Education, Experience and Analysis is Risk Intelligence achievable and even then it is not guaranteed.

And in addition, Education, Experience and Analysis are the cure for the irrational biases found by the psychologists. I would bet that the psychologists systematically excluded any responses from a person with Risk Intelligence. That would have invalidated their investigation.

Their conclusion could have been that many of us need basic financial and risk education, better understanding of how to accumulate helpful experiences and some basic analytical skills. Not as much fun as a long list of cutely names biases, but much more helpful.

Irrational means you don’t agree with me

February 5, 2014

The term “Rational” is used in economics to mean using the decision process that results in the best economic outcome.

And the best economic outcome is often defined as the one that results in the highest amount of money for the decision maker.  That at least is the theory.  There is an entire body of analysis under the title “Game Theory” that shows how such Rational Decision making would apply to many situations.

Herbert Simon actually showed a fundamental flaw in approaches like Game Theory and other forms of economic rationalism.

The flaw is that to really satisfy the rules of rationality, the decision maker would need to have infinite time to make the decision and would also need access to all knowledge, all of which must be reviewed to see if it pertains to the problem.

So Simon proposed that what was really meant by economists when they used the idea of rational decision making was something that he called “Bounded Rationality”.  The boundaries to rationality were necessary to get to a decision before tea time next spring.

Rational decision makers needed to apply heuristics to determine the actual amount of time and the pertinent information that would be needed for making any decision.  Heuristics are seen as the opposite of rationality.  They are the “gut feel” way to decide something.  So Simon showed that Rational Decision Makers must be using gut feel.

Just think if physicists considered anyone who did not solve physical problems using the best equations that physicists have to offer as “irrational”.  Everyone who drives a car, or catches a ball, would be found to be totally irrational, because those activities always rely upon heuristics, rather than physics equations.  Instead, physicists would readily admit that the person who can run across Center Field and arrive at just the right time to catch the baseball is actually properly applying physics, instead of the opposite.

And RISKVIEWS would extend Simon’s arguments to suggest that the heuristics used are not neutral to the decision.  “Rational” decision makers will all apply their own heuristics to decide what needs to go into a decision.  Some of those heuristics will be based not on a “rational” evaluation of the value of information not included or analysis not performed, but it will be biased to leave out the information and analysis that leads away from their preferred solution.

What Simon deduced is that there is no purely rational decision making process.

And RISKVIEWS is saying that anyone who proposes that their decision is made rationally should be suspect.  Are they using the term rational to persuade?  Or do they not even know about the limitations of their own analysis?

Good analysis should include information about the way that the analyst decided on the boundaries for that analysis.  Someone who simply states the assumptions underlying their analysis is not giving you a solution, they are giving you a puzzle to solve.  The solution to the puzzle is the knowledge of when the analysis may be true and when it may be untrue.  Solving that puzzle involves understanding the bounded rationality of the analyst and the degree to which reality may or may not be outside of those bounds.

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