By |Published On: January 10th, 2013|Categories: Research Insights, Behavioral Finance, Value Investing Research|

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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About the Author: Wesley Gray, PhD

Wesley Gray, PhD
After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia 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 firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016). Dr. Gray currently resides in Palmas Del Mar Puerto Rico with his wife and three children. He recently finished the Leadville 100 ultramarathon race and promises to make better life decisions in the future.

Important Disclosures

For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Third party information may become outdated or otherwise superseded without notice.  Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency has approved, determined the accuracy, or confirmed the adequacy of this article.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).

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