The first principle is that you must not fool yourself, and you are the easiest person to fool—-Richard Feynman, Nobel Prize in Physics
Confirmation bias is a real problem for all sorts of problem solving—political, military, social, and economic. It refers to the cognitive bias where we look for evidence that confirms our existing opinion, and tend to ignore, dismiss, or refuse to look for evidence that would contradict what we already believe.
Science proceeds along the opposite path, with an attempt to actively seek disconfirming evidence and to keep an open mind about the data. That process, first of all, requires data. You can’t improve a process until you measure it. As the saying goes, “without data, you’re just another dude with an opinion.”
Even when you have data, you’ve got to be open to alternative explanations of your hypothesis. Experiments have to be designed to tease apart what effects are really operational. In a laboratory, you can control the inputs to a large extent. In social science, economics, or financial markets, you’re stuck with messy datasets and often you have only probabilities, not necessarily clear-cut cause-and-effect relationships.
Correlation is not the same thing as causation, and this is where much junk science founders. For example, if you know that all heroin addicts drank milk when they were young, this does not mean that milk is a “gateway” drug for heroin. Although a relationship exists, it is not causal. You can read absurd claims in the press all the time, where it’s never clear if you’re looking at a cause, an effect, or just a coincidental correlation.
The main problem with junk science is that it causes people to mistrust real relationships in the data, because they are so used to seeing bogus relationships touted as important. At that point, arguments often center on idealogy—and the data is ignored.
Here is something that is often lost when arguing about issues: you can’t fake reality. When asked if he believed in psychological warfare at the chessboard, Bobby Fischer replied “I believe in good moves.” You can believe whatever you like about a bullet coming toward you—but you’re going to be just as dead as the next guy if it hits you. In short, trying to understand the underlying reality is important.
Market prices provide great insight into the underlying reality. If markets are not doing what you think they should, the market is probably right and you are probably letting confirmation bias fool you. (Prices reflect the current expectations around a situation—not necessarily the correct expectations. If circumstances cause expectations to change, you can expect that market prices could have quite an adjustment too.) With a lot of smart people wagering significant sums of money on outcomes, prices are often our best guide to the probable future. Prices are going to reflect reality as best it can be determined. Ignore them at your peril.
