Notes on the Psychology of the Betting Market 2: Models
Models are the cornerstone of strategic decision making in betting and financial markets. But it's important to remember that these models are representations of reality, not reality itself. Understanding which models and idealizations are appropriate for the task at hand and which aren't is critical for success. Additionally, over-reliance on statistics-based models can lead to flawed conclusions and significant bouts of over-confidence..it is funny how often the model gets it wrong just as the bet size is growing.
The construction of a model is always a choice of which observations to include and which ones to exclude, and these choices reflect the underlying motivations of the modeller, which are often unconscious. It is important to be aware of these motivations and the potential biases that are likely to be at work.. All models, including risk models, have limitations, and it's important to be aware of these limitations. However, when faced with unexpected events, models can break down, and the temptation to cling to them due to an intolerance of failure and alternative perspectives can be detrimental.
Models are highly sensitive to our subjective prior assumptions, which are inevitably tainted by noise. As traders in financial and betting markets, it's crucial to avoid crude approximations, to focus on what's truly important, and to remain humble in our analysis rather than becoming overconfident. We must also be vigilant in identifying and mitigating any unconscious biases that may influence our analysis.
The most effective model is one that accounts for the available data in the most parsimonious way. However, it's important to remember that no model can fully capture reality or truth. Models are tools, windows into the data, and the inferences we make from them are always subjective. As traders operating in financial and betting markets, it is imperative that we use models judiciously, understanding their limitations and the presuppositions and biases of their designers. In the end of the day, like it or not, the truth will always exist beyond the scope of the model.
The construction of statistical models involves a number of subjective elements, such as the choice of hypotheses, model assumptions, and prior distributions for model parameters. These choices can have a significant impact on the output of the model, as changes in the prior distribution can lead to changes in the likelihood ratio or the distribution of model parameters. This is known as sensitivity analysis.
It is important to note that our models are often viewed as extensions of ourselves, and the model we construct is always the one that we consider to be the best. However, this requires a sophisticated understanding of which models and idealizations are adequate for the reality they are trying to describe, and which are irrelevant or misleading. Additionally, we should be aware that models are often constructed by making distinctions and choices about which observations to include, and these choices may be unconsciously motivated, or indeed (as so often the case) just plain wrong.
Risk models can be effective in predicting certain outcomes, but they can be unreliable when unexpected events occur, and the correlations they rely on can break down. An overconfidence in models can lead to an unwillingness to consider alternative perspectives, which can result in retaining the model for far longer than is warranted. The construction of models is also subject to biases based on expectation or self-interest, and they are often highly sensitive to subjective prior assumptions.
The best model is the one that accounts for the available data in the most parsimonious way, but all models are ultimately limited by the information available at the time of construction. Models should be seen as convenient windows through which we can view and make inferences about the data at hand, but these inferences are always subjective and can be influenced by emotionally charged biases. Additionally, it is important to note that models do not attempt to explain real-world behavior, they only attempt to explain model behavior, and they are never truly representative of reality. Models depend on the presuppositions of their designers and reflect their biases. They can assist us in the discovery process, and allow us to understand patterns and to make predictions, but we should always remember that the truth almost always eludes and lies outside of the model. Models are always based on past observations and thus are unable to capture the new and unexpected - the truths that exist outside of the current state of affairs.
In Nuce, our understanding of the world is based on a set of assumptions and expectations that are derived from past experiences and data, and these assumptions and expectations form the basis of our statistical models. However, these models are based on the assumption that the world is stable and predictable, and as a result, they are not often able to account for the emergence of new truths that fundamentally disrupt and transform our understanding of the world.
In situations where models are used to inform decisions that affect many people, it is important to have a system of checks and balances in place to ensure that the models are being used appropriately and that the potential risks and limitations are being considered. This may include involving multiple stakeholders in the decision-making process, performing sensitivity analyses to understand the model's uncertainty, and regularly reviewing and updating the model.
Models can and do provide valuable insights and they can help us to identify trends, patterns, and relationships that might not be immediately apparent. They can provide a framework for thinking about how different factors might interact under different circumstances and help us to better understand complex and dynamic systems. Ultimately, howeverr, it is important to recognize that models are only one part of the decision-making process, and that they should be used in conjunction with other forms of analysis and information. It is also important to have a clear understanding of the potential risks and limitations associated with any model, and to be transparent about these when presenting or using the model.
All information contained on this website is for informational purposes only. Investors should always consult with a financial adviser before making any investment decision and should not treat any opinion expressed on this website as a specific inducement to make a particular investment. Share prices because they are driven by a multiplicity of factors that it is difficult to disentangle at any one point in time move forward on a nonlinear trajectory. In other words, it impossible to predict the future, especially when it comes to timing. In the end of the day it is always about scaling your risk appropriately.
To cite this article: Niall O'Connor
Notes on the Psychology of the Betting Market 2: Models (Published on Bettingmarket.com 06/03/2023. From the series Notes on the Psychology of Trading. All Rights Reserved.)