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Taleb Tetlock
Taleb Tetlock
York University
of Pennsylvania
2 University
Contents
1
References
On the Difference between Binary Prediction and True Exposure With Implications For Forecasting Tournaments and
Decision Making Research 2/6
Alleged Bias
Misspecified domain
Justified domain
Dread Risk
Comparing risks
of driving vs flying
Bounded bets in
laboratory setting
Lotteries
Convex financial
payoffs
Application
Erroneous
domain
Justified domain
Prediction
markets
Revolutions
Elections
Prediction
markets
Sports
Forecasting
On the Difference between Binary Prediction and True Exposure With Implications For Forecasting Tournaments and
Decision Making Research 3/6
xi
20
10
-10
-20
xi
50
0
-50
-100
-150
-200
-250
On the Difference between Binary Prediction and True Exposure With Implications For Forecasting Tournaments and
Decision Making Research 4/6
e
(1 + )1+
0.6
0.5
0.4
0.3
0.2
0.1
-4
-2
2
3
Let us compute the probability of coin flips n of having 50% higher than the true mean, with p= 12 and = n2 :
2
P S 32 2n 2e 3 = en/24
which for n = 1000 happens every 1 in 1.24 1018 .
On the Difference between Binary Prediction and True Exposure With Implications For Forecasting Tournaments and
Decision Making Research 5/6
fHxL
Vanilla
P>1 = P<1
1
1
1
1
erfc
= 1 erfc
2
2
2 1a
2 a+1
(1)
So then, for different values of a in Eq. 1 as we can see in
Figure 2, the probability of staying inside 1 sigma rises, rare
events become less frequent.
Note that this example was simplified for ease of argument.
In fact the tunnel insideqof which fat tailedness
q increases
1
probabilities is between 2 5 17 and 12 5 17
(even narrower than 1 in the example, as it numerically corresponds
area between -.66 and .66), and the outer one
q to the
1
is 2 5 + 17 , that is the area beyond 2.13 .
3.3 The law of large numbers works better with the
binary than the variable
Getting a bit more technical, the law of large numbers works
much faster for the binary than the variable (for which it may
never work, see Taleb, 2013). The more convex the payoff,
the more observations one needs to make a reliable inference.
The idea is as follows, as can be illustrated by an extreme
example of very tractable binary and intractable variable.
Let xt be the realization of the random variable X (-,
) at period t, which follows a Cauchy distribution with p.d.f.
1
f (xt ) (x 1)
. Let us set x0 = 0 to simplify and make
( 0 2 +1)
the exposure symmetric around 0. The variable exposure
maps
R
to the variable xt and has an expectation E (xt ) =
xt f (x)dx,
which is undefined (i.e., will never converge to a fixed value).
A bet at x0 has a payoff mapped by a Heaviside Theta Function >x0 (xt ) paying 1 if xt > x0 and 0 otherwise.
The expecR
tation
of
the
payoff
is
simply
E(
(x))
=
(x)
f (x)dx=
>x0
R
f
(x)dx,
which
is
simply
P(x
>
0).
So
long
as
a
distribux0
tion exists, the binary exists and is Bernouilli distributed with
probability of success and failure p and 1p respectively .
The irony is that the payoff of a bet on a Cauchy, admittedly the worst possible distribution to work with since it
lacks both mean and variance, can be mapped by a Bernouilli
distribution, about the most tractable of the distributions. In
this case the variable is the hardest thing to estimate, and the
binary is the easiest thing to estimate.
Set Sn = n1 ni=1 xti the average payoff of a variety of
variable bets xti across periods ti , and S n = n1 ni=1 >x0 (xti ).
No matter how large n, limn S n has the same properties the exact same probability distribution as S1 . On
the other hand limn S n= p; further the presaymptotics
of S n are tractable since it converges to 12 rather
quickly,
and the standard
deviations
declines
at
speed
n , since
q
q
p
)
V
S
(
(1p)p
1
V (S n ) =
=
(given that the moment genn
n
n
erating function for the average is M(z) = pez/n p + 1 ).
Binary
Bet
Level
x
(2)
(3)
On the Difference between Binary Prediction and True Exposure With Implications For Forecasting Tournaments and
Decision Making Research 6/6
Acknowledgments
Bruno Dupire, Raphael Douady, Daniel Kahneman, Barbara
Mellers, Peter Ayton.
References
Barberis, N. (2013). The psychology of tail events: Progress
and challenges. American Economic Review, 103(3), 611-16.
Chernoff, H. (1952), A Measure of Asymptotic Efficiency
for Tests of a Hypothesis Based on the Sum of Observations,
Annals of Mathematic Statistics, 23, 1952, pp. 493507.
Mellers, B. et al. (2013), How to win a geopolitical forecasting tournament: The power of teaming and training. Unpublished manuscript, Wharton School, University of Pennsylvania Team Good Judgment Lab.
Silver, Nate, 2012, The Signal and the Noise.
Taleb, N.N., 1997, Dynamic Hedging: Managing Vanilla and
Exotic Options, Wiley
Taleb, N.N., 2001/2004, Fooled by Randomness, Random
House
Taleb, N.N., 2013, Probability and Risk in the Real
World, Vol 1: Fat TailsFreely Available Web Book,
www.fooledbyrandomness.com
Tetlock, P.E. (2005). Expert political judgment: How good is
it? How can we know? Princeton: Princeton University Press.
Tetlock, P.E., Lebow, R.N., & Parker, G. (Eds.) (2006). Unmaking the West: What-if scenarios that rewrite world history.
Ann Arbor, MI: University of Michigan Press.
Tetlock, P. E., & Mellers, B.A. (2011). Intelligent management of intelligence agencies: Beyond accountability pingpong. American Psychologist, 66(6), 542-554.
the indent for the numbered sections