Simple Models Beat Experts: Even in Investment!

Simple Models Beat Experts: Even in Investment!

January 10, 2013 Research Insights, Value Investing Research
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(Last Updated On: January 13, 2017)

One of the more fascinating findings from psychology research is the empirical finding that simple models often beat experts.

In other words, insights from your “gut” often smell like Sh#$.

 

Experts have been bested by simple models in a variety of arenas. Some favorites:

Wine Quality

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Brain Damaged?

Leli and Filskov (1979) reported cross-validated classification accuracy that equalled 83% for a discriminant function derived on two measures of intellectual deterioration. This investigation made a preliminary assessment of the clinical utility of this function through a clinical-actuarial classification paradigm. Wechsler-Bellevue Intelligence Scale Form I protocols from 12 nonpsychotic nonimpaired and 12 cerebrally impaired individuals were used by experienced clinicians and predoctoral interns to identify the presence of intellectual deterioration associated with brain damage through their own clinical experience (Clinical Judgment condition) and, then, in conjunction with the discriminant function (Clinical-Actuarial condition). The classification accuracy from the discriminant function weights (Actuarial condition) and those from clinicians in the Clinical-Actuarial condition were statistically comparable and significantly above chance levels. These results indicate that the clinician who is assessing for the presence of intellectual deterioration associated with brain damage should rely heavily upon a valid actuarial index.

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Psychotic vs. Neurotic

But, what do we call that process which is characterized by a disruption of the naturally occurring order of observations  plus immediate feedback on cue-criterion links, followed by some concrete form of tallying the accuracy of one’s hypotheses? We call it RESEARCH [authors emphasis]

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One of the greatest pieces written on the subject comes from none other than James Montier:

Painting by the Numbers

Could it be the case that simple models beat “experts” in the stock market? I’m not sure, but the evidence from our book certainly suggest this to be the case!

London


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Definitions of common statistics used in our analysis are available here (towards the bottom)




About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.