Saturday, April 22, 2023

"Memory and Probability"

From Verdad Advisers, March 27:

Behavioral economists connect the way our memory works to how we make probability judgments

In the first few months of the COVID pandemic, a group of behavioral economists surveyed Americans about their beliefs about the lethality of the pandemic. The survey found that the young dramatically overestimated their own risk, the elderly underestimated their own risk, and health problems were associated with higher levels of pessimism. And, perhaps most interestingly, people who overestimated the percentage of Americans with red hair were among the most pessimistic about COVID’s lethality.

These results don’t seem to fit into any standard behavioral models. But the economists who ran the survey believe these responses can be explained by the way human memory works and the role our memories have in shaping the way we understand the present and forecast the future.

The economists argue that older people have had more experience and, because they evaluate new experiences relative to a large database of memories, are less reactive. They remember surviving many other non-COVID adversities, so they underestimate the risk posed by this novel disease. The economists call this phenomenon “interference.”

The young, in contrast, respond more intensely to frightening media stories. This reaction pattern is similar to other behavioral economics studies that find that people will overpay to insure against specific, salient events (e.g., buying insurance right after a disaster hits). Young people don’t have a large set of memories of other adversities interfering with their thinking, and they are therefore more likely to be overly triggered by a novel, specific threat made salient on the news or social media.

People who overestimate the share of people with red hair are more likely to make generalizations based on their own experience and thus overestimate rare events. Overestimation of COVID lethality was correlated with a general inability to make good probability assessments.

The lead author on this COVID study, Pedro Bordalo, is now out with a major new paper he co-authored with Andrei Shleifer and Nicola Gennaioli called “Memory and Probability.” Their paper seeks to generalize these findings on memory and probability to offer a new model that can reconcile seemingly contradictory findings from behavioral finance around over and under reaction....

....MUCH MORE 

Verdad was founded by a Harvard Man, Daniel Rasmussen, who went from Bain to Bridgewater Associates to setting up shop as Verdad to making his bones replicating private equity but without the fees to getting crushed in small cap value in the early stages of Covid to making some decent money out of the V-shaped recovery. Here's Institutional Investor in 2018 with some of their story and here's Forbes in 2021 with more. He seems a straight-shooter, if a bit brash, sort of like the fifteen-year-old who thinks their generation is the first to discover sex. We've linked to a dozen or so  of Verdad's communiques.

Andrei Shleifer is also a Harvard Man. He seems creepy and something of a jerk:When the Harvard Boys Did Mother Russia (Steyer and Summers, Shleifer and Sachs)