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December 6, 2011 / theslowblitz

The Power of Intuition

A rational donkey stands poised equidistant from two equally tempting bales of hay. As both bales of hay are equally tempting, the donkey is unable to decide which bale to eat, and therefore starves to death. This is the paradox of Buridan’s Ass, a paradox aimed straight at the heart of rationality. Given two equal options, it would seem that rationality stops in its tracks.

Perhaps the rational donkey has considered beforehand the possibility of such an impasse, and decides beforehand that he would the left bale of hay in such a situation. This still leaves some questions to be answered. How would the rational donkey know that both bales of hay are actually equal, that neither bale has an apple hidden inside it? Why should the rational donkey always turn left, instead of right?

These questions may continue into infinity. The reason that we, unlike Buridan’s Ass, do not starve to death while making even the simplest decisions, is because we rely on intuition. Whenever faced with a fork in the road, we tend to turn right first. This is not a decision based on reason. We may always justify the decision with reason (“I prefer the products on my right more”), but new questions may always arise that bring the reason into doubt (“How do you know that the arrangement of the aisles haven’t changed?).

At some point, we stop questioning, especially in circumstances where we know nothing, having tried and failed to solve the unsolvable. Let us consider the bicycle designer. Even today, what keeps a bicycle upright while riding is a mystery to science. The most common theory, that the bicycle stays upright due to gyroscopic forces has been shown to be insufficient. What the bicycle designer does then, is rely on experience and intuition to determine the most effective arrangement of the four components of the bicycle – without understanding why it is so.

It seems then that hedge fund managers are being unfairly criticized when their understanding of how derivatives work is brought into question. The economy is inherently complex and difficult to understand. Even the best minds in the world are at loggerheads as to how it works, why should the hedge fund managers? As long a formula works, which is evident in the successes of the recent boom years, then I would not fault them for simply accepting it as is, the same way we accept how our cars, companies and laws work. It just does.  

Those who blindly followed the hedge fund managers are difficult to fault as well. It is difficult for any one person to be at once an economist, a scientist and philosopher. At some point, we have to refer to the authority of individuals. The vetting that may be done by reason is limited. To more clearly understand this, let us look at a common refrain: “You should have known this could not go on forever.”

When your property agent tells you house prices are rising due to population growth, an influx of immigrants and increasing wealth, he sounds perfectly reasonable. You don’t know enough about population movements and economics to prove him wrong, nor are you familiar with the other factors affecting housing prices. Thus, you believe him. It would not make be rational for you to investigate further; you are busy with organizing your child’s birthday celebration, and even if you looked, the economic mumbo jumbo deters you.

Hindsight is always 20-20. It is easy to say the hedge fund managers should have looked harder. Maybe, but maybe looking harder isn’t the point. No matter how hard you look at a puzzle you cannot solve, the puzzle does not solve itself. Humans are intuitive creatures, and we are intuitive for a very good reason. I would not fault people for doing something both natural and extremely useful in most circumstances.

Citations

Gyroscopic effects not sufficient explanation of bicycle mechanics:
http://socrates.berkeley.edu/~fajans/Teaching/MoreBikeFiles/JonesBikeBW.pdf

Extra readings

The power of intuition:
http://discovermagazine.com/2011/sep/18-your-brain-knows-lot-more-than-you-realize/article_view?b_start:int=0&-C=

Interesting tidbit from another article:
http://www.nytimes.com/2011/10/23/magazine/dont-blink-the-hazards-of-confidence.html?pagewanted=all

“True intuitive expertise is learned from prolonged experience with good feedback on mistakes. You are probably an expert in guessing your spouse’s mood from one word on the telephone; chess players find a strong move in a single glance at a complex position.

To know whether you can trust a particular intuitive judgment, there are two questions you should ask: Is the environment in which the judgment is made sufficiently regular to enable predictions from the available evidence? The answer is yes for diagnosticians, no for stock pickers.

Do the professionals have an adequate opportunity to learn the cues and the regularities? The answer here depends on the professionals’ experience and on the quality and speed with which they discover their mistakes. Anesthesiologists have a better chance to develop intuitions than radiologists do. Many of the professionals we encounter easily pass both tests, and their off-the-cuff judgments deserve to be taken seriously. In general, however, you should not take assertive and confident people at their own evaluation.”

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