3 Things I Think I Think - Weekend Edition

by: Cullen Roche

Here are some things I think I am thinking about: decision-making under the Gambler's Fallacy, the worthlessness of "Wall Street" and the state of American living standards.

1 - Decision-making under the Gambler's Fallacy. Here's a super interesting paper from Daniel Chen, Tobias J. Moskowitz and Kelly Shue which finds some unusual relationships:

We find consistent evidence of negative autocorrelation in decision-making that is unrelated to the merits of the cases considered in three separate high-stakes field settings: refugee asylum court decisions, loan application reviews, and major league baseball umpire pitch calls. The evidence is most consistent with the law of small numbers and the gambler's fallacy - people underestimating the likelihood of sequential streaks occurring by chance - leading to negatively autocorrelated decisions that result in errors.

In English, this means that human beings suffer from recency bias. As a result of this our current decisions are significantly influenced by recent events. But here's where it gets interesting:

We find that umpires are 1.5 percentage points less likely to call a pitch a strike if the previous pitch was called a strike, holding pitch location fixed. This effect more than doubles when the current pitch is close to the edge of the strike zone (so it is a less obvious call) and is also significantly larger following two previous calls in the same direction. Put differently, MLB umpires call the same pitches in the exact same location differently depending solely on the sequence of previous calls. We also show that any endogenous changes in pitch location over time are likely to be biases against our findings.

Now, when I played baseball I couldn't even hit the same spot twice with a pitch so I can't relate to this, but this is pretty interesting. And for those of you who get frustrated watching umps make bad calls when we can see that big electronic strike zone on the TV, well, maybe robots taking jobs makes more sense now….

2 - Will Wall Street Create Value in the Future? Here's a letter to the WSJ from John Bogle who writes-in arguing against this piece which essentially argued that the world would be far worse without Wall Street. I rarely disagree with John Bogle, but I think he goes a little overboard here. "Wall Street" is a big tent that now encompasses much more than a place in Manhattan. There's banks, investment banks, brokerage firms, trading firms, market making firms, exchanges, hedge funds, venture capital, private equity, etc., etc. Obviously, a lot of these businesses offer something useful. Providing an electronic payment system is one of the most advanced and useful technologies we have in the world. Making markets in the public arena allows savers to diversify their savings. Investment banking helps match innovators with funding. There aren't just a handful of useful business on Wall Street.

Of course, as the Nohria piece notes, we're coming off a financial crisis and a period of unprecedented financialization of the US economy. So we're still working off some of the excess and yes, they are being worked off (look at FIRE employment for instance). And while I think we should all be cognizant of problems on Wall Street I think these blanket dismissals of a vast industry is unhelpful. It just stokes the ideological fire that we seem to be seeing in American politics these days and we all know that thinking isn't going to result in helpful compromise. I've argued that Wall Street is probably too big and could be better regulated, but let's not overreach here….

3 - The Rising Decline of American Living Standards. Here's a depressing set of stats from the Fed:

  • Forty-six percent of adults say they either could not cover an emergency expense costing $400, or would cover it by selling something or borrowing money.
  • 31 percent, or approximately 76 million adults, are either "struggling to get by" or are "just getting by."

Now, this has to be put in some context because we know that American living standards have risen in recent decades. But at the same time, this data makes me wonder if we shouldn't be thinking about this differently. Yes, our living standards are rising, but if we saw broader wage growth and income equality I wonder if living standards wouldn't be that much higher. I suspect that's a better way to think of things. Regardless, the recession doesn't feel like it ever ended for a whole lot of people and that is pretty depressing. Especially when you consider how bad the policy initiatives have been in the last 7 years (much of which I think is the result of the type of ideological thinking we see in point 2)….