Robin Hanson has a great
post today on how people invariably overestimate their own abilities, and
therefore come to the conclusion that if something’s wrong, it’s not their fault
and it must be something terribly broken elswehere. He quotes Kahneman and Lovallo
as finding
that
A typical result is that respondents are only correct on about 80% of cases
when they describe themselves as "99% sure."
And he shows that people with no knowledge of specifics are often much better
forecasters than people on the inside with much better information.
I couldn’t help but be reminded of Bear Stearns’ letter to investors in its
failed hedge funds:
The Funds’ reported performance, in part, reflects the unprecedented declines
in the valuations of a number of highly-rated (AA and AAA) securities.
Unprecedented, we tell you! So it can’t possibly be our fault!
Except, of course, for a couple of small things. Firstly, credit ratings are
not designed to act as some kind of guarantee against mark-to-market losses;
they’re merely an indication that the probability of default is low, which is
quite another thing entirely. And secondly, anybody who saw the gapping out
of all spread product in 1998 knows that many AA and AAA securities can and
will decline in value quite substantially if there’s a flight to quality/liquidity.
But I don’t need to pick on Bear Stearns here: in fact I’m struggling to come
up with a single hedge-fund collapse which didn’t blame some kind of
"unprecedented" event.