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Perils of non-linear predictions show up

Unfortunately, the stock markets are an even more non-linear system. Besides having a wide variety of poorly-knowable inputs, it is a system in which its own outputs are continuously becoming further inputs, like a vicious circle, writes Dhirendra Kumar.

india Updated: May 17, 2009 22:25 IST
Dhirendra Kumar

To loosely paraphrase Danny DeVito in some movie, ‘No one can foretell the future. That’s why it’s called the future.”

That’s a lesson that’s always been there for all manner of soothsayers and their followers to learn. You couldn’t tell this from watching the news channels, but the electorate has made an even bigger joke of psephologists and pollsters than it has of Lalu Yadav, Paswan and the Left.

I feel this rather strongly as an investment analyst and advisor. Election pollsters may crawl out of the woodwork only once in a while, but their investment equivalents are in business all the time, even though they have been wrong almost all the time. Over the last two years, they’ve been wrong first on the way down, and then on the way up.

The basic problem is not that this or that psephologists or analyst doesn’t know how to do his job, but that this job cannot be done, at least in any useful way. Almost by definition.

Indian elections are what would be called a non-linear system in science or maths. In such systems, small changes in inputs produce large changes in the output. These changes are neither proportional to, nor even necessarily in the same direction as the changes in input.

A first-past-the-post parliamentary election with a huge number of fragmented battlefields is severely non-linear. At any reasonable sample size, perfectly reasonable sampling errors would magnify to such huge deviations in the final results that the entire exercise will be meaningless. There’s no hope of making a correct prediction, except a fluke once in a while. As the results of the past many elections prove, this is an exercise that can’t succeed.

Or maybe not. Whether this exercise was a success or not actually depends on what its goal was. I’m just naively assuming that the goal was to make correct predictions.

However, there should be no such ambiguity about the purpose of predictions about stock markets. Those should have a precisely-defined goal—to help people make more money, or at the very least, to help them lose less money. Unfortunately, the stock markets are an even more non-linear system. Besides having a wide variety of poorly-knowable inputs, it is a system in which its own outputs are continuously becoming further inputs, like a vicious circle.

Interestingly, while both systems seem immune to systematic analysis, in my experience they both yield to the instinctive understanding of people.

In these elections, practically every experienced journalist who had traveled across the country would privately say that the Congress was likely to sweep the polls. Once upon a time, this would have been the view that the media would have carried. Unfortunately, we have developed a mindset where we would rather trust half-baked systems with a veneer of science and ignore the instincts of the experienced.