After nailing the 2008 election, and expanding his fan base beyond baseball stats geeks, FiveThirtyEight.com blogger Nate Silver is set to prove himself the world’s best pundit in any area that involves numbers. Obviously, that would include the markets.
His first big stab at analysing the markets and economics is up at Esquire.com, where he rejects the notion that the downturn somehow came totally out of the blue. Such thinking, he said, is simply the result of recency bias, the tendency to look at just a couple years of history, rather than the long-term:
I decided to set up a rudimentary statistical experiment. Suppose it’s January 2008 and you’re an investor — or an economist — trying to forecast the probability of a major downturn in the United States economy. We’ll define such a downturn as occurring any time real GDP falls at an annualized rate of 4 per cent in any one quarter, which is about equal to the decline experienced in the fourth quarter of 2008. Between 1947 and 2007, quarterly GDP fell by this amount on eleven separate occasions.
About the simplest economic model one can build is to assume that fluctuations in GDP occur randomly and follow a normal bell-curve distribution. From there, it is reasonably straightforward to calculate the percentage chance of a “crash” — a 4 per cent decline in GDP — in any given quarter.
The rest of the column is basically a history lesson, with a little bit of Nassim Taleb and Steve Leavitt thrown in. In other words, a little bit of psychology and a whole lot of hindsight bias. Not a bad first effort, but we hope he actually gets in the business of predicting stuff, like he does with politics. C’mon Nate, tell us what the stock market is going to do next quarter, or at least in the next year! Then we’ll be really excited.