Saturday, July 16, 2016

The Power of Wishful Thinking

Tim Harford writes a great column (The Undercover Economist) for the Financial Times.  This weekend's essay is titled, "Brexit and the Power of Wishful Thinking."   He derives an important lesson from the widespread Brexit analysis about the way we adhere to our preexisting beliefs.   

Harford begins by describing an experimental study conducted by Guy Mayraz.  In this research, Mayraz asks research subjects to predict the future price of wheat.   He first provides participants with 3 months worth of historical wheat price data.  He informs the subjects that they will be paid based on the accuracy of their forecasts.   Mayraz assigns 1/2 of the participants to play the role of a farmer, while the other 1/2 of the subjects play the role of the baker.  What happens?  According to Harford, "Nearly two-thirds of farmers predicted higher-than-average prices, and nearly two-thirds of bakers predicted lower-than-average prices.  People tended to predict that their dreams would come true."    Harford then draws a connection to the Brexit situation.   He argues that Remain supporters engaged in rampant wishful thinking leading up to the vote by they British public.  People tended to forecast that their dreams would come true, rather than looking objectively at the situation. 

Similarly, Harford argues that many people have displayed confirmation bias in their post-vote analysis.  He counts himself as one of the culprits.  Harford explains that he looked at the drop in the value of the pound and the decrease in the FTSE 100 index as support for his preexisting view that Brexit would have a painful impact on the UK economy.  On the other hand, he dismissed the subsequent stock market rebound because it did not support his position.  "I accepted bad news when it chimed with my beliefs, and dismissed good news when it did not." 

What should we do about this wishful thinking and confirmation bias?   Harford advocates for scenario planning rather than to construct single forecasts.   Harford writes, "Because scenarios are persuasive stories, they can help us face up to uncomfortable prospects and think clearly about possibilities we would rather ignore.  And because scenarios contradict each other, they force us to acknowledge that, in the end, we cannot actually see into the future."  

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