Desktop Stock Ticker | Calibration

Calibration

In a previous post, we saw how humans have an overconfidence bias, and how that can play havoc on financial forecast estimations. What is not immediately clear, though, is the increasing role overconfidence plays the more knowledge one buys. That is, as expertise rises, so does overconfidence, resulting in the fact that the people with the most knowledge are likely to be the most miscalibrated, which can result in detrimental effects.

But knowledge alone does not doom someone into being arrogant. James Montier argues that it’s a lack of feedback that pushes people to be arrogant. To exhibit this, Montier cites a study performed by Scott Plous that compares the calibration of weathermen against that of doctors. Weathermen were questioned to predict the weather, while doctors were questioned to diagnose patients (based on case notes). Both were questioned to provide confidence intervals, so that their calibrations could be measured.
Fascinatingly, weatherman were well calibrated, while doctors were very poorly calibrated. Montier argues that this is because weather forecasters benefit from the fact that they receive immediate evidence of their abilities as forecasters, while doctors do not.
While one may be inclined to believe that financial analysts should be like weathermen in that they can see whether their forecasts came right, <a href="http://books.google.ca/books?id=aCGX-WSj3e0C&pg=PA111&lpg=PA111&dq=montier+%22average+suitability+and+confidence+on+stock tickers+selection%22&source=bl&ots=AnrnRyc4df&sig=PKST_znweywZqcZiFSQ2wKYy_H8&hl=en&ei=6BaXS8_DE5P0sgPN3LzCAQ&sa=X&oi=book_result&ct=result&resnum=1&ved=0CAYQ6AEwAA#v=onepage&q=&f=fake”>similar calibration tests appear to show that analysts are calibrated to a similar extent as doctors! As a result, <a href="http://books.google.ca/books?id=aCGX-WSj3e0C&pg=PA111&lpg=PA111&dq=montier+%22average+suitability+and+confidence+on+stock tickers+selection%22&source=bl&ots=AnrnRyc4df&sig=PKST_znweywZqcZiFSQ2wKYy_H8&hl=en&ei=6BaXS8_DE5P0sgPN3LzCAQ&sa=X&oi=book_result&ct=result&resnum=1&ved=0CAYQ6AEwAA#v=onepage&q=&f=fake”>the industry is glowing with overconfidence. Further testing confirmed the opening hypothesis: <a href="http://books.google.ca/books?id=aCGX-WSj3e0C&pg=PA111&lpg=PA111&dq=montier+%22average+suitability+and+confidence+on+stock tickers+selection%22&source=bl&ots=AnrnRyc4df&sig=PKST_znweywZqcZiFSQ2wKYy_H8&hl=en&ei=6BaXS8_DE5P0sgPN3LzCAQ&sa=X&oi=book_result&ct=result&resnum=1&ved=0CAYQ6AEwAA#v=onepage&q=&f=fake”>experts in finance are more arrogant than lay people, as they apply too narrow a band around their estimates as compared to the general public.

This article was written by Saj Karsan of Barel Karsan. If you loved this article, please vote for it by clicking the Buzz Up! button below.

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