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Thursday, 12 June 2014

B is for Base Rate Neglect

Base Rate Neglect is the all-too-human tendency to ignore the background rate at which some event occurs when trying to assess how probable it is. It's a facet of how our brains are poorly attuned to statistics.

Example

Base rate neglect tends to go hand in hand with our preference for narrative over numbers. A study on this topic, Stories vs Statistics, showed that a group of experienced business managers were perfectly able to choose the most reliable equipment when provided solely with statistics - but as soon as anecdotes were introduced casting doubt on the reliability of the best machine their success rate dropped from 96% to 42% (*). It's the same problem people suffer from with lotteries - we only ever see pictures of happy smiling big winners, not the millions of sadly resigned, repeated, small losers.

Causes

The cause is undoubtedly a combination of nature - our brains weren't evolved to deal with statistics - and nurture - we simply don't receive enough training in how to interpret statistics. In the modern world this ought to be rather more important than, say, how ox-bow lakes form or whether Columbus discovered the New World before the Vikings, American Indians and beavers. Useful information though this may, the time would be better spent equipping people to understand whether the drug they're being offered will really improve their health or whether that confident fund manager is really beating the market (hint: they almost certainly aren't, once you adjust for risk).  

Mitigation

You need a rudimentary grasp of statistics and a willingness to ask simple questions when presented with impressive figures or stories. Remember that markets regularly overreact to news, without considering the long-term implications of events. Always ask "so what"?

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