Sunday, November 8, 2015

Assessment of risks and identify - Who you are may define how you view risks

We are not very good at weighing evidence. We make assessments about issues and then decide, but our decisions are often based on our cultural identity. Asked if they can image evidence that would contradict their view and then ask if they would change their minds if presented the evidence, the answer for many was no. These are the findings of Dan Kahan and others who have done research work in cultural cognition.  This has been the focus of a growing number of researchers at the cultural cognition project

The Cultural Cognition Project is a group of scholars interested in studying how cultural values shape public risk perceptions and related policy beliefs. Cultural cognition refers to the tendency of individuals to conform their beliefs about disputed matters of fact (e.g., whether global warming is a serious threat; whether the death penalty deters murder; whether gun control makes society more safe or less) to values that define their cultural identities.

Cultural identity will have an impact on how research is presented and will bias how managers may look at a problem. For example, Larry Summers and has views of secular stagnation present one model and cultural view that will affect forecasts of Fed action. This filter will have a big impact on how he looks at new information about the economy. If you agree with Summers, you will view data in a similar fashion. Some may call this just a model view, but there may be more going on here. This view may bias what you think the Fed will do with interest rates. You cannot divorce your cultural view with your forecast.

The standard approach for cultrual cognition is to use the following 2x2 matrix to describe how groups may filter information. I don't think this model applies to finance, but a model bias or view of the world will affect how the likelihood function is used when given new information is presented.

I will argue that systematic modelers are different than discretionary decision-makers who may have a greater cultural bias or are influenced by the cultural norms of their peers in the industry. There is a New York - London global macro bubble and those who are in it  are more likely to think alike and look at data differently than the systematic manager who is away from a major city. 

Keynes was aware of this when he discussed beauty pageants and the willingness to fail with others rather than thinking on your own, as well as the issue of many being ruled by the ideas of some defunct economist. 

“Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.” 
― John Maynard KeynesThe General Theory of Employment, Interest, and Money

Cultural norms will affect risk perceptions and what data is important in the macro-economy. This is not a well-defined idea in finance, but I think it is well worth further discussion. 

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