Global Crisis Blog

Can We Trust the Intuition of Experts?

By Shlomo Maital

Nov. 10/2009

 

    An article in the latest American Psychologist, by Daniel Kahneman and Gary Klein, addresses the key issue:  When can we trust the intuitive judgment of experts? [1]

    Kahneman is identified with the HB (heuristic bias) approach.  His work, some of it done with the late Amos Tversky, shows how flawed our judgment is and how non-rational our decisions often are.[2]  Kahneman won the Nobel Prize in Economics for his research.

    Klein is identified with the NDM (naturalistic decision making) approach, which chronicles often-amazing successes of intuitive judgment.  The article is an interesting dialogue between the two approaches, ending in “a failure to disagree”, i.e. broad agreement.

     Here is what the two scholars agree upon:

  • · An environment of high validity is a necessary condition for the development of skilled intuitions. Other necessary conditions include adequate opportunities for learning the environment (prolonged practice and feedback that is both rapid and unequivocal).If an environment provides valid cues and good feedback, skill and expert intuition will eventually develop in individuals of sufficient talent.

  Although true skill cannot develop in irregular or unpredictable environments, individuals will sometimes make judgments and decisions that are successful by chance. These “lucky” individuals will be susceptible to an illusion of skill and to overconfidence.   The financial industry is a rich source of examples.

    Let me translate.   If the ‘environment’ of decision-making is stable and predictable (i.e. that of a chess game),  experts develop startlingly accurate intuitive judgment.  Chess grandmasters, for instance, can choose the best move quickly in complex situations when amateurs fail to even consider that move.  But if the environment is unstable and unpredictable,  expert intuition is flawed.  True, such judgment will be right part of the time.  But this is solely through chance.   Those who ‘hit it’ by chance become overconfident, take excessive risk — and destroy their own businesses and the capital of others. 

      If “the financial industry is a rich source of examples” of flawed intuition,  then those enormous bonuses the industry is again paying itself are not justified.  Nor can we put our faith in investment advisors with superior rates of return over the past year.  Probably, an accident.   We can, however, better understand Warren Buffett’s surprisingly accurate intuition.  It is based on investing from the outset ONLY in stable environments, i.e. basic products like food, drink, machine tools or railroads, and holding on to the equities for decades.  

      Kahneman and Tversky once investigated the phenomenon of the ‘hot hand’ in basketball (streaks of baskets, without misses, by star players) and showed statistically that there was no such thing — it was simply random.  (Toss enough coins, and you will eventually get a dozen straight ‘heads’).   Why, then, do we still believe in ‘hot hands’ among financial advisors?   And why have they returned to paying themselves obscene bonuses? And why do we the people agree to it?   

       And finally, why in the world would anyone believe, in a world of overconfidence in flawed intuition in the financial services industry,  that the 2007-9 global crisis will not recur? 

   

 

 


[1] “Conditions for Intuitive Expertise: A Failure to Disagree”,  American Psychologist, Sept. 2009.

[2] See S. Maital, “Daniel Kahneman: on redefining rationality”, J. of Socioeconomics, 2004.

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