“Intuitively, an accurate forecast is more likely to have been made by a forecaster who has better judgment and is better able to evaluate the situation. Here we argue that there is a simple reason why this intuition may be wrong. Rather than being an indication of good judgment, accurately forecasting a rare event…may in fact be an indication of poor judgment…

…The reason is that a forecaster of poor judgment is more likely than a forecaster with good judgment to predict the rare and extreme event…We show analytically that if a manager predicted that an event would be extremely successful, and the prediction turns out to be correct, this manager may in fact have poor forecasting ability. In other words, an accurate judgment can be a signal of poor judgment. The explanation is that because extreme outcomes are very rare, managers who take into account all the available information are less likely to make such extreme predictions, whereas those who rely on heuristics and intuition are more likely to make extreme predictions. As such, if the outcome was in fact extreme, an individual who predicts accurately an extreme event is likely to be someone who relies on intuition, rather than someone who takes into account all available information.”, Jerker Denrell and Christina Fang, “Predicting the Next Big Thing: Success as a Signal of Poor Judgment”, June 6, 2010

“…right now we’re still dealing with the aftermath of a once-in-three-generations financial crisis…”, Paul Krugman, New York Times, April 28, 2013

“We were seeing things that were 25-standard deviation moves, several days in a row”, David Viniar, Chief Financial Officer, Goldman Sachs, Financial Times, August 13, 2007

“I know that I made good business judgments in the years leading up to the financial crisis (and during the financial crisis) based upon all the information available at the time. I believe this paper goes a long way to proving that just because a good business judgment later turns out to be wrong, that does not with the benefit of hindsight make it a bad judgment (it makes it inaccurate). This is why both corporate directors and officers deserve the full protection of The Business Judgment Rule. Also, this paper makes clear that those Big Shorts probably did not exercise good business judgment at the time they placed their bets, even though with the benefit of hindsight they were correct and financially extremely successful.” Mike Perry, former Chairman and CEO, IndyMac Bank

 

Predicting the Next Big Thing: Success as a Signal of Poor Judgment

Denrell, Jerker and Fang, Christina, Predicting the Next Big Thing: Success as a Signal of Poor Judgment (June 7, 2010).
Management Science, Vol. 56, No. 10, pp. 1653-1667, 2010.
Available at SSRN: http://ssrn.com/abstract=1621800

Posted on May 22, 2014, in Postings. Bookmark the permalink. Leave a comment.

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