strategy+business is published by PwC Strategy& Inc.
 
or, sign in with:
strategy and business
Published: June 17, 2009

 
 

The Statistician Who Ate Humble Pie

Nassim Nicholas Taleb, author of The Black Swan: The Impact of the Highly Improbable, introduces an engaging lesson in business forecasting from Dance with Chance: Making Luck Work for You, by Spyros Makridakis, Robin Hogarth, and Anil Gaba.

Just about every human decision about the future is tainted by a gap — the difference between what we think we know and what we actually know. The more expert we are, the wider the gap is likely to be. The story below, an excerpt from the book Dance with Chance, is a classic example of an expert-busting enterprise. The experts in this case are highly sophisticated statisticians and professors who are using up-to-date models. Most of us assume that sophistication helps us understand the future. But in fact, sophistication makes things worse; it invites misplaced focus on the complicated. In the end, if we expect to make better decisions, we would do well to internalize the lesson in this passage. That doesn’t mean relying on common sense. It might mean looking for experts who understand the limits of what they know and the relative value of simpler methods.

— Nassim Nicholas Taleb 


Excerpted from chapter 9 of
Dance with Chance: Making Luck Work for You


As an expert in statistics, working in a business school during the 1970s, one of the authors…couldn’t fail to notice that executives were deeply preoccupied with forecasting. Their main interest lay in various types of business and economic data: the sales of their firm, its profits, exports, exchange rates, house prices, industrial output…and a host of other figures. It bugged the professor greatly that practitioners were making these predictions without recourse to the latest, most theoretically sophisticated methods developed by statisticians like himself. Instead, they preferred simpler techniques which — they said — allowed them to explain their forecasts more easily to senior management. The outraged author decided to teach them a lesson. He embarked on a research project that would demonstrate the superiority of the latest statistical techniques. Even if he couldn’t persuade business people to adopt his methods, at least he’d be able to prove the precise cost of their attempts to please the boss.

Every decent statistician knows the value of a good example, so the professor and his research assistant collected many sets of economic and business data over time from a wide range of economic and business sources. In fact they hunted down 111 different time series, which they analyzed and used to make forecasts — a pretty impressive achievement given the computational requirements of the task back in the days when computers were no faster than today’s calculators. They decided to use their trawl of data to mimic, as far as possible, the real process of forecasting. To do so, each series was split into two parts: earlier data and later data. The researchers pretended that the later part hadn’t happened yet and proceeded to fit various statistical techniques, both simple and statistically sophisticated, to the earlier data. Treating this earlier data as “the past,” they then used each of the techniques to predict “the future,” whereupon they sat back and started to compare their “predictions” with what had actually happened.

Horror of horrors, the practitioners’ simple, boss-pleasing techniques turned out to be more accurate than the statisticians’ clever, statistically sophisticated methods. To be honest, neither [were] particularly great, but there was no doubt that the statisticians had served themselves a large portion of humble pie.

One of the simplest methods, known as “single exponential smoothing,” in fact appeared to be one of the most accurate. Indeed, for 61.8% of the time it was more accurate than the so-called Box-Jenkins technique, which represented the pinnacle of theoretically based statistical forecasting technology back in the 1970s. The academic journals of the day had proven that the Box-Jenkins method was more accurate than large econometric models where predictions were based on hundreds of equations and impressive volumes of data. So, by extension, single exponential smoothing was also more accurate than the grand-scale econometric models that cost hundreds of thousands of dollars to develop and use!

 
 
 
Follow Us 
Facebook Twitter LinkedIn Google Plus YouTube RSS strategy+business Digital and Mobile products App Store

 

This Reviewer

  1. Nassim Nicholas Taleb is the distinguished professor of risk engineering at Polytechnic Institute of New York University and a visiting professor at the London Business School, where he codirects the Decision Research Laboratory. He is the author of The Black Swan: The Impact of the Highly Improbable (Random House, 2007) and Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets (Random House, 2005).

This Excerpt

  1. Dance with Chance: Making Luck Work for You, by Spyros Makridakis, Robin Hogarth, and Anil Gaba (Oneworld Publications, 2009)
  2. Spyros Makridakis is professor emeritus at INSEAD, a school that he first joined in 1970. He has won awards both for his teaching and for his research, which includes 20 books and more than 120 articles and book chapters. He has held teaching and research positions at several European and U.S. institutions, has provided many organizations with consultancy and advice, and has served on the boards of several companies.
  3. Robin Hogarth lives and works in Spain, where he is a research professor at Universitat Pompeu Fabrais. He was formerly a member of the faculty at the Graduate School of Business at the University of Chicago, INSEAD, and the London Business School. He has published many books and papers, and has provided consultancy services for numerous organizations in Europe and the U.S.
  4. Anil Gaba is the ORPAR Chaired Professor of Risk Management and the dean of faculty at INSEAD's Asia campus in Singapore. His articles have appeared in the popular press as well as in academic journals, and he is a regular consultant and speaker for multinational companies, especially in the financial-services sector.
 
Close
Sign up to receive s+b newsletters and get a FREE Strategy eBook

You will initially receive up to two newsletters/week. You can unsubscribe from any newsletter by using the link found in each newsletter.

Close