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Thursday, July 09, 2009

The Limits of Models

Here's an excellent piece on the Psi-Fi Blog, titled "Quibbles With Quants." Here's a choice part:
What the models failed to capture was that humans don’t behave in simple, predictable and uncorrelated ways. It’s impossible to overstate the importance of the way these models cope with correlation of peoples’ psychology. To sum it up: they don’t. Let me know if that’s too complex an analysis for the mathematical masters of the universe.

Anyone who’s ever been to a nightclub, a football game or even a very loud party will know that there are situations where we don’t act as individuals, buzzing about doing our own thing. These are occasions when we all suddenly stop being individuals and start doing the same thing – usually involving large quantities of drugs and some very bad singing. Although these sorts of events are specifically designed to trigger this behaviour – which is probably a deep evolutionary adaptation to sponsor group behaviour, useful when it comes to running down tasty antelope and dealing with giant, carnivorous sabre toothed beavers – it can also happen in other situations. Most stockmarket booms and busts are generated by similar group effects.

In general, people behave in an uncorrelated fashion right up until the point they don’t.

Read the whole thing here.

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