Statistical Illiteracy

In yesterday’s Guardian Cory Doctorow railed against the inability of the general public to understand statistics. His targets were people who spend a fortune on lotteries, parents who get hysterical about media-driven panics and ignore the fact that far more kids die in car accidents than from anything the papers get in a tizzy about, and so on. But that’s not the only place where statistical illiteracy causes problems. Even those who are supposed to be experts get things wrong. By coincidence, on the same day, The Economist was worrying about an excess of testosterone in financial markets, and the effect this has on understanding of risk.

You see, there’s a fair amount of research supporting the idea that, left to their own devices, men tend to be less risk averse than women. And The Economist has also turned up evidence that over the past 10 years, when rampant risk taking became endemic in financial markets, leading eventually to economic collapse, the proportion of women working in the US financial sector dropped markedly (in contrast to the rest of the US economy where it grew).

For a couple of years during that period I was working for a company that sold derivative valuation software, so I had direct experience of the sort of attitudes that were prevalent in the industry. I can’t claim that my experience is anything like a reasonable sample of attitudes, but I sure saw a lot of macho disregard for risk analysis.

Over at the BBC Robert Peston is talking about Lord Turner and the Basle III regulatory programme. Peston says of Turner:

So he is encouraged by the latest international agreement by central bankers and regulators, the so-called Basel lll agreement, that will force banks to hold more capital as protection against future losses.

This is good news. What they are talking about is what risk professionals call “capital adequacy”. Look at it this way: if you go into a casino, do you buy chips with the cash you have in hand and are prepared to lose? Or do you buy a pile more chips on a credit card on the assumption that you are not going to lose so it doesn’t matter if you don’t have the money to pay the credit card bill? A primary cause of the financial meltdown was that too many companies had bet more than they could afford to lose. Basle III is trying to stop them doing that.

Will it work? I’m skeptical. The reason we got into such a mess was that too many bosses and too many politicians, were not willing to look at the potential downside when they were on a big winning streak. The lure of big wins was just too great. A bit more statistical literacy would be a good thing all round. And possibly a bit less testosterone too.

6 thoughts on “Statistical Illiteracy

  1. Any suggestions of well received studies about “You see, there’s a fair amount of research supporting the idea that, left to their own devices, men tend to be less risk averse than women.” Would like to read up. can do so, but if you reference studies you found interesting could turn something up I might not have found.

    Just curious. I find the topic interesting. And not just because I get frustrated by macho risk-taking, I swear. (:

    Good post.

  2. There was a book a few bubbles ago (“Adam Smith”??) which popularized the expression describing the most admired, rapacious traders as “big swinging dicks.”
    (ah — I Google the phrase to see how widespread it is — 12,000 Google hits — and the first link is about the book: Liar’s Poker about the 80’s bond market.)

  3. Yes indeed .. ” Liar’s Poker .. Two Cities, True Greed ” a terrific book , I just opened my copy at random and came upon a passage in which they were trying to avoid losing $100 million that was their stake in B.P. way back in the ’80s …. peanuts really, eh wot?

    I consider that most of the financial problems that we are experiencing now have their roots in attitudes born in the birth of the modern Bonus Culture in the 1980s of ‘Liars Poker’

    Strange how the lesson of the failure of Barings Bank was never learned by the politicians of New Labour. I see that Nick Leeson – the archetypal ‘Rogue Trader’ – is doing quite well in the era of the credit crunch ..

  4. The really ironic thing is the very last comment:

    “Half the people in this country have a below average understanding of statistics.”

    Spoken by someone who truly doesn’t understand statistics yet thinks they do.

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