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On the Difference between Binary Prediction and True Exposure With Implications For Forecasting Tournaments and Decision Making Research

On the Difference between Binary Prediction and True Exposure With Implications For Forecasting Tournaments and Decision Making Research

Nassim N. Taleb, Philip E. Tetlock

Abstract
There are serious statistical differences between predictions, bets, and exposures that have a yes/no type of payoff, the “binaries”, and those that have varying payoffs, which we call the “variable”. Real world exposures tend to belong to the variable category, and are poorly captured by binaries. Yet much of the economics and decision making literature confuses the two. variable exposures are sensitive to Black Swan effects, model errors, and prediction problems, while the binaries are largely immune to them. The binaries are mathematically tractable, while the variable are much less so. Hedging variable exposures with binary bets can be disastrous–and because of the human tendency to engage in attribute substitution when confronted by difficult questions,decision-makers and researchers often confuse the variable for the binary.

https://docs.google.com/file/d/0B_31K_MP92hUZFRrQk1VOExqMUE/edit?pli=1

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