Outside Edge

Of foxes, hedgehogs and the art of financial forecasting

The fantastic Mr Fox is on course for another famous victory. FT Money has a tradition of holding a year-end competition to forecast some key financial indicator, and easily the most distinctive competitor is a fox in the garden of the columnist Kevin Goldstein-Jackson, who gives his forecasts by consuming one of a variety of appropriately labelled pieces of chicken. (I refer not to Mr Goldstein-Jackson but to the fox.)

If the method is quirky, there’s no arguing with the results: the fox was the most accurate forecaster in 2008 and 2009 and, barring a year-end rally, the fox will win again in 2011. Such repeated success is an outstanding achievement against fields of about a dozen rivals.

Since the fox is a taciturn competitor, we cannot directly ask it for forecasting tips. A few lessons do, however, suggest themselves. The first is that extreme forecasts have an excellent chance of winning such contests because professional forecasters will huddle together for protection and the eventual outcome is rarely close to the cosy consensus.

Most competitors predicted a bloodbath in UK housing for 2009, for example. The fox predicted a modest fall and scooped the plaudits when house prices actually rose. This year, the fox predicted a 19 per cent fall in the FTSE 100. That looks far too pessimistic, but since every single professional pundit predicted a rise of at least 3 per cent, the fox may well win again. Intriguingly, when a new fox cub took up the challenge and lost in 2010, it made the rookie error of plumping for a forecast in the middle of the field.

The second lesson follows from the first. Professional pundits are not usually paid to make correct forecasts. They are paid to sound convincing, whether they are columnists or figureheads for asset managers. An extreme-sounding forecast can occasionally pay off – those who predicted disaster in the mid-2000s will be set up for the next few years at least – but there is safety in the consensus, especially when coupled with slick patter.
“The fox eschews the consensus and peddles no patter. Its results speak for themselves”

The fox eschews consensus and peddles no patter. Its results speak for themselves. Yet has the fox been offered any prestigious City jobs? Exactly.

The fox has, perhaps, been lucky, but nobody who studies the subject of forecasting will be surprised. The psychologist Philip Tetlock, author of the modern classic Expert Political Judgement, conducted a two-decade investigation into the accuracy of expert forecasts in social sciences. He discovered that regardless of academic field, practical experience, gender or political persuasion, experts make very poor forecasts. By some measures, the “chimp strategy” of randomly predicting that things will get better, or get worse, or stay much the same, matches the best the experts can do. Mr Goldstein-Jackson’s fox is in good company.

Mr Tetlock did find one way of dividing up his experts in a way that correlated with less-awful forecasting ability: that of “cognitive style”. Harking back to an essay by Isaiah Berlin, and before him to the Greek poet Archilochus, Mr Tetlock points to the “hedgehogs”, people who view the world through the lens of a single, powerful, logical idea. They make hopeless forecasters. Less hopeless are intellectually promiscuous, self-doubting dabblers. They are called, of course, “foxes”.

Also published at ft.com.

24th of December, 2011Outside Edge • Comments off