In the Blind Spot of the Mind’s Eye

Adolf Fischer, a British labor activist was innocent yet tried and sentenced to death in 1887. With the rope around his neck, and shortly before the trap opened below his feet, he screamed that this is the happiest day in his life. He died with his goals unachieved.

One year after Fischer was hanged, a bright young fellow perfected the process of dry photography, launched his revolutionary Kodak Camera, and instantly became one of the richest men in the world. In 1932, the wealthy man surprised everybody by killing himself.

To our simple mind, the part that thinks fast, the outcomes of these 2 lives seem contradictory. How can a rich man who has achieved all the goals he set for himself commit suicide while a poor guy who hasn’t achieved anything and sentenced while innocent claim that he is dying happy?

The above can be partially explained by the fact that when our brain has incomplete information about a situation, it tends to take the information it has as all there is, and make simplistic assumptions to fill in the gaps and grasp the rest of the situation. Daniel Kahneman calls this WYSIATI (What You See is All There Is).

Our retina is attached to our brain by a nerve. At the intersection we have a blind spot. But our eyesight is not interrupted. We never see this blind spot. Why? Because our brain takes the information it has about the surrounding of the blind spot to assume what the content of the blind spot should be, and complete it. I tried the below experiment from the book. Unless you are reading this article on an iPad don’t try it, it won’t work on your computer. As your right eye gets closer to the magician, the earth at some point will go through your eye’s blind spot. Your brain will see the white around it and assume that the content of the blind spot should be white, and the earth will disappear. It will reappear when you get past the blind spot.

Our memory retrieval process, like our eye, performs multiple filling in when it has incomplete information. And given that at any single moment, our senses are getting a multitude of information and our brain is going through an infinity of thoughts, it is virtually impossible to store all this information in our memory. When we want to remember how we felt in the past, we remember highlights, ups and downs, but also random stuff, and our brain fills in the rest. Therefore, the process of remembering how we felt at some point back in time is a far from perfect process. And given that we make most of our decisions for the future based on our past experience, we end up making the wrong choices some times over and over again.

Read on a bit about George Eastman and Adolf Fischer to find out that in short, Fischer died as a hero while Eastman was suffering from a terrible spine illness, which might explain a bit better the different views they had on their lives, but aren’t these simplifications that suffer from the filling in illusion as well?

Note: This is part 2 of my book review of Stumbling on Happiness. itallics are verbatim copy paste from the book. You can find part 1 of the book review here.

To be continued

Despite how Hard you Try, you’re Probably not Going to be Happy

Daniel Gilbert’s book that I have just finished reading for the second time in 2 years is not a self help book. Anyone that takes psychological advice from someone who is not licensed or trained to give it should have their head examined, he says. Now when you find out that Daniel Gilbert is a Psychology PhD from Princeton and Professor at Harvard, you probably would want to listen on what he has to say. And what he has to say, simplistically, could be summarized in one sentence: your brain is not a good tool to forecast what is going to make you happy.

I personally do not take any of the below views for granted, but would like to share them to take feedback and explore other view points. Also, writing a book review is a great way to remember the book, and exposing it to the scrutiny of the readers by publishing it is a good exercise to force me to check the validity of what I am writing.

Anything in italics in this note is a verbatim extract from the book, anything else is either a paraphrase or my own interpretation.

The Human Being is the Only Animal that Thinks about the Future

And it makes many mistakes while doing so. In the late 1960’s, a Harvard Psychology Professor took LSD, resigned his appointment, went to India, met a Guru and went back to write a book called Be Here Now of which the key message is that the key to happiness was to stop thinking so much about the future.

Now anyone who has a sane frontal lobe knows that not thinking about the future is close to mission impossible. We think about the future mostly because we want to have control over it. Research shows that being effective, changing things, influencing things is a fundamental need for our brain, and that losing control is a major source of depression.

We insist on having all this control, but the truth is that all these efforts for control are in vain, not because don’t know where we are going, but because the destination looks different than it appears through the prospectiscope. Why?

Subjectivity

Lori and Reba Schappel have a few unusual things in common, namely a portion of their brain. They are craniopagus conjoined twins. Yet they claim to be happy, something almost inconceivable in our singleton’s mind.

Hypothesis 1

‘They may think they’re happy, but that’s only because they don’t know what happiness really is’, we could say. In other words, we may think that it is because Lori and Rebba have never had many of the experiences we Singleton had that they talk about their experiences differently. Imagine we gave a birthday cake to L & R and asked them to rate their experience on a scale of 1 to 8. The following picture illustrates the experiment.

If we believed the results of the above experiment, then we better be worried. If L&R have not experienced some of our experiences, we haven’t experienced some of theirs either. For instance, we have never experienced the sense of comfort from knowing that our lifetime partner, sister and best friend will never leave us no matter what we do.

Our Brain: The Great Story Teller

After some time off my keyboard and my books due to the birth of our startup PricePinz, I have decided to take some time off on this beautiful Singaporean Sunday to finish some left over book reviews. For those of you who liked Part 1 of my review of Thinking, fast and slow or those who were intrigued by the TED talk I have posted, this is for you.

You think you understand it all

Kahneman quotes Taleb in one of the portions of the book I like most, the one that explains the concept of Narrative Fallacy. Narrative fallacies are in short stories which our brain constructs to simplify reality, classify it, and archive it in little boxes in our subconscious. Our brain does not deal well with stories that it cannot extract a logical conclusion from, and therefore, if this logical conclusion is lacking, it invents it.

Black-Scholes, LTCM and Where Mathematics can Fail to Model the Markets

The 1970’s and 80’s signaled the rise of financial mathematics as a powerful tool to make constant returns from financial markets. Fischer Black and Myron Scholes had planted the seeds for what was going to be the foundation of derivatives pricing for the years to follow in their 1973 paper: The Black-Scholes Model.

For years since then, financial mathematician, traders and quants worked on tweaking this formula to make it model more closely the realities of the markets.

In 1997, Myron Scholes was awarded the Nobel prize in Economics for his work, along with his colleague Robert C. Merton. Both of them then decided to make the leap from academia to the markets, and sat on the board of Long Term Capital Management (LTCM) which made returns as high as 40% in its first few years.

The following videos recount the tragic story of LTCM, its rize to fame and catastrophic failure, and open the debate around financial mathematics modeling.

So what is next after financial mathematics then? Artificial Intelligence?

 

Experience vs Our Memory of It

Did you ever wonder what could be the reasons why the future you imagined has got nothing to do with what it ends up being?

Could it be that your brain is tricking you into making the wrong decisions?

This video is beyond the regular TED talk. You’re listening to a genius.

If you like it, read my book review of Daniel Kahneman’s work.

Is the Future more Random than what we Think it is Going to be?

I recently discovered a paper by famous economist Robert Shiller which had I find amazing findings in terms of how we perceive the future and how it ends up being. I sent an email to Nassim N. Taleb to take his opinion in it, and he replied telling me that it was mentioned in his book Fooled by Randomness. I was quite surprised with his reply, especially after I had read Fooled by Randomness inside out, but I guess the reason the paper’s results didn’t stick in my mind is that the graph that is essential to the paper is not shown in Taleb’s book.

For starters: one of the most widely used models to value a stock price is Gordon’s Growth Model which states that stock prices should be equal to the present value of all future dividends earned by the stock. This is quite intuitive, as otherwise, why would you pay more to own a piece of paper (share or stock) which earns you less than the present value of all future dividends on it?

Shiller then had the following brilliant idea: if stock prices should be equal to the present value of all future dividends earned by owning the stock, then let’s take a look at how these present values of actual future dividends compare with… the actual future itself.

The results are shown in the following graph:

The red curve, P*, is the present discounted value of actual subsequent real dividends, and the blue curve is the value of the S&P.

What do you think? Does the blue line look like a close approximation of the red line it was trying to forecast?

Shiller’s paper title is “Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?” I guess by now the answer should be pretty clear.

I guess this marvelous finding has more than one interpretation. Philosophically, one might think about the following question: Is the future more random than what we think it is going to be, partly because of the fact that we overreact to our expectations of it?

Shiller’s paper can be and can be found here: http://www.math.mcmaster.ca/~grasselli/Shiller81.pdf

They Called him Mr. Doom until Doomsday Happened. My Review of Roubini’s Lessons on Crisis Economics – Part 2

Plate Tectonics – Continued

This is Part 2 of my review of Roubini’s Crisis Economics, and I take over from where Part 1 ended, which was describing the causes of the Global Financial Crisis. The following parts of this book review will describe the perfect storm that followed the Lehman Brothers Collapse and the spread of the crisis to the rest of the world. The reactions of the US government and especially the Federal Reserve were spectacular, but the transfer of the risks and liabilities from the private to the public sector has considerable repercussions. Roubini shows how the haste of quelling the crisis made policy makers miss a unique opportunity to reform the system, and explains how the system we are in at the moment has become riskier than the one which was prevalent before the crisis. We essentially moved from a network of institutions that were too big to fail to one of institutions too big to be saved. Do not read this note if you are about to go to bed unless you are ready for some insomnia.

Sometimes a Single Graph Tells So Much!

Often economics is about finding the right chart to express a certain phenomena. Take a look at the 3 distinct periods above:

• Before 1999 and the creation of the Euro: Yields on the Greek, Spanish, Italian and Portuguese are much higher than the ones of France and Germany.
• From 1999 to 2008: Yields of all Euro countries converge dramatically. To get a sense of the reason for this, read the first paragraph of Part 3 of my note on the Euro Crisis.
• From 2008 and the onset of the crisis onward: Yields diverge dramatically again, but this time with the same currency across all Euro countries!

I find this to be quite a good illustration of what was happening.

Source: http://www.npr.org/blogs/money/2012/06/04/154282337/the-crisis-in-europe-explained

The Eurozone on the Verge of its Dismembering. My Attempt at Explaining the Drama in Europe in Simple Words – Part 3 & 4

Part 3: Disappearance of Currency Risk & the Animal Spirits

One Unified Rock Solid Currency Across Heterogeneous Economies

In addition to the factors explained in Part 1 and 2 of this note, one should note the role that the disappearance of currency risk played on the movements of assets within the Eurozone. To simplify, the creation of a unique currency made it possible for assets and liabilities to be matched across borders like never before. German investors could own Italian assets and Spanish investors could own French assets without risk of currency loss. With the flick of a switch, currency risk disappeared. As a consequence, investors who wanted to hold Euros and who have the choice to hold either German Euro debt or Spanish Euro debt for example naturally went for the safer and more prosperous economy. In such a case, what should normally happen is that yields on Spanish debt should rise, but they didn’t, and the reason to that is that the northern European nations were willing to lend to the periphery at relatively low interest rates, as the surpluses generated by Germany were recycled into real estate booms in Spain and elsewhere. The growing imbalances were as much the fault of the creditors – northern European financial institutions and their regulators – as of the debtors.

The Eurozone on the Verge of its Dismembering. My Attempt at Explaining the Drama in Europe in Simple Words – Part 2

Part 2: The Mercedes and the Feta Cheese

As we have seen in part 1, debt in the periphery of the Eurozone has climbed to allegedly unsustainable levels as a consequence of the crisis more than as a cause of it. So if it’s not debt, then what are the underlying causes of the fault lines in Europe? Part 2 of this note will explore the consequences of productivity imbalances within the members of a monetary union.