The ambiguities of experience - impacts decision-making

 

James March is one of the great professors of organizational management, yet finance and investment professionals rarely discuss or even consider much of his work. This is odd because organizations, not individuals, make so many investment decisions. Organizations through investment committees are a key driver of all institutional action. Organizations manage risk and provide oversight of individual managers.

In his older book, The Ambiguities of Experience, March focuses on the paradox that experience "may be the best teacher" but "is not a particularly good teacher". Organizations are driven by their experiences, yet the links between action, decision, outcome, and learning are often not clear. The problem is that there are a number of ways to interpret the link between action and outcome. We have discussed this before in our work on “wicked” environments. 

Experience can be noisy because there are a number of links with any action. We cannot always say that our action caused an outcome. Our experiences are also selective. We will often focus on the decisions we made that turned out to be correct and dismiss our incorrect actions. Similarly, success and failure can be misleading. If something worked well, we will likely repeat it. If some action fails, we are likely to stop, yet this stopping rule may not be correct when there are probabilistic outcomes. Additionally, the world changes, so the lessons in the past may not apply, and our aspirations of what is successful also change. There is ambiguity because the environment is complex, noisy, endogenous, constructed, and miserly from small samples.

Experience may not contain the correct lessons for investors or traders. There is ambiguity about what happened, why it happened, whether it was good or bad, and whether our actions affected the results. There is superstitious learning that just because some action of ours is followed by some result, the takeaway is that we did that. Is experience unreliable? No, but it should be tempered. 

The key issue for investors and any asset management organization is that causal inference is difficult. The problem permeates all organizations and inference is not an issue that is left to science. Organizations like individuals will have behavioral biases associated with group action and decisions. Organizations have to engage in exploration to learn and then engage in a conversion into exploitation or the action from the learning.