What Wisdom of Crowds?
Irrationality of the herd still governs human behavior.
If there's anything to be learned from the unwinding of this credit bubble, it's this simple reminder: The amount we do not know about our instinctual motivations to herd and swarm -- even in situations where such behavior is seemingly at odds with our own best interests -- dwarfs what we do know about the "power" of individual human decision-making.
Not long ago I ran across a fascinating article in the New York Times science section on swarming behavior, specifically in ant colonies and among locusts. Dr. Iain D. Couzin, a mathematical biologist at Princeton University and Oxford, observed that army ants are particularly good at moving in swarms; if they have to travel over a depression in the ground, they erect bridges so that they can proceed as quickly as possible. Compare that to the 3.7 billion hours a year American spend trapped in traffic.
What Dr. Couzin wanted to know, however, was why army ants don't move to and from their colony in a mad, disorganized scramble. With the power of computers, he was able to model their behavior and discover some of the feedback ants rely on in organizing and swarming successfully. As the Times points out, however, "Understanding how animals swarm and why they do are 2 separate questions."
While studying locust swarms, Dr. Couzin learned that, even when 2 "swarm leaders" present conflicting views to the group, the swarm was still able to decide which leaders to follow to preserve the swarm.
"As we increased the difference of opinion between the informed individuals, the group would spontaneously come to a consensus and move in the direction chosen by the majority," Dr. Couzin said. "They can make these decisions without mathematics, without even recognizing each other or knowing that a decision has been made."
And this is where we return to human decision-making abilities. Dr. Couzin teamed up with researchers at the University of Leeds to study human behavior. Given a set of rules, and even presented with hidden and conflicting information, the human swarm made a quick, unconscious decisions about which way to go.
The experiment is unique, but the observation that humans tend toward herding -- and even follow unconscious decisions about crowding and swarming -- is not particularly new. A remarkable book about crowds and the power they afford individuals is presented in Elias Canetti's book Crowds and Power, a must-read for any market participant.
The larger takeaway from the Times article, especially in light of credit-market behavior, is this: In spite all of our pricing models and the new, scientific-sounding nomenclature and its attendant swarm of acronyms -- SIV, ABCP, ARS, CDO, CMO, ETC. -- we're still human beings governed by herding impulses - and aren't quite as removed from irrationality and misunderstanding as we presume.
This is your brain on quantitative risk models in February 2009.
And this is your brain on the banks of the Rhine River a couple of hundred thousand years ago having just caught a fish with your bare hands.
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