Although the title to this post is long and sounds like the beginning of a boring academic journal essay, I assure you I will summarize. My goal is to show how a vast majority of the economic, finance, and statistic literature regarding the markets is less useful than an issue of TV Guide. Three mental heuristics are responsible for the continued belief in failed fields of academia.
The Belief in Experts
The role of an expert has long been a coveted title in human society. It is the expert that calms our fears and outlines the risks. In most circumstances following the advice of an expert is a wise decision, however, you must define what type of expert you are seeking advice from. The title of "expert" in itself does not guarantee "expertise."
For Example, if you are about to have surgery it would be prudent to listen to surgeon regarding the possible options and complications. The surgeon has performed surgery and is peer reviewed on constant bias. The rightful title of expert is given to the surgeon, however, would you buy a stock that the surgeon recommended during a period of idol conversation? If you said no, than you are probably deluding yourself.
The human brain has a hard time separating context and definition. If a person is labeled an expert in a certain field, we tend to view them simply as intelligent and capable overall. As a thought experiment lets change up the surgeon analogy I just used. You meet a man at your grandmother's cocktail party, we will call him Dave. Dave strikes up a stirring conversation and you glean that he went to medical school at Harvard. Over the course of the discussion Dave starts telling you about his hobby of investing his portfolio and how successful he has been. Before parting he imparts on you some of his investment wisdom and recommends a stock that cannot fail. Would you be more willing to invest on Dave's advice? Studies show that you would simply because he said Harvard and your brain equated Harvard to intelligence.
The Problem of Group-Think
There is a difference in types of experts. Doctors come from a field that regularly employs the scientific method and has a peer hierarchy that checks and refutes studies performed. There are mistakes but the results of modern medicine are clearly proven as humans continue to have longer life spans. Economics on the other hand has a bad track record and does not employ any type of empirical research. Yet, presidents still defer to economic experts when drafting a policy, why?
The answer is that people view professors of any field as an expert, if they were not smart they would not be a professor at MIT, right? Wrong, the reason people still view an economist as an expert when making investment decisions is because we fall for the expert bias and the group-think bias. If polled, most people would agree that a economics professor at MIT is an expert in the field of economics. The fact that others believe is going to make you believe, because who are you to argue with the rest of society? We do not like to make decisions that run contrary to public opinion, regardless if that opinion is wrong.
Hindsight Bias
The heuristic that brings all of this together is the hindsight bias. I have been extra hard on the study of economics in this post, not because I do not like economists, but because despite the empirical data the markets still believe in their wisdom. The reason the reputation of the economist is still untarnished is due to the hindsight bias. When economic theory is implemented and fails it is easy for economist to state that it was astronomically rare event or pin the blame on a scapegoat such as the government. When we look back at past events humans like to believe that the reason for those events is clear.
For example, the 2001 terrorist attacks on the United States are completely understood. It was a massive failure of intelligence communication that allowed the attacks to take place, or was it? The attack happened because it was unexpected. If the attack had been expected it probably would not have happened. But our brains need a reason for events and the reason that has been popularly accepted is a failure of the CIA and FBI.
Summary
The assumptions of modern economic, financial, and mathematical literature are still popular and widely followed beliefs. The existence of such literature is dependent on society's collective mental biases. For these reasons, investing in the stock market on existing theories and ideals will always lead to disaster. That is why the need for empirical research regarding human behavior and the markets is incredibly valuable to a portfolio. So before you believe what a market "expert" tells you, ask yourself, "do I believe him because he has an empirical approach or because he seems really smart?"
Please remember, I summarized a massive amount of information into a few paragraphs. If you have questions or would like more information please leave a message in the comments. Also, I appreciated criticism as long as you acknowledge that this is a blog post and do not attack on a personal level.
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