What's Past is Not Prologue

5 Pages Posted: 8 Aug 2018  

James White

Elm Partners

Jeffrey Rosenbluth

Elm Partners

Victor Haghani

Elm Partners

Date Written: April 1, 2017

Abstract

In this note we present several thought experiments involving coin-flipping to illustrate the common tendency to over-weight past data in forecasting the future, particularly in the context of investment returns. We start by describing a survey we conducted of about 700 respondents involving the identification of a biased coin. From there, we connect a simple coin-flipping thought experiment to the challenge of picking good investments based on past returns. We then develop a more realistic model (moving on from coin-flipping) that shows the difficulty in discerning attractive investments from within a pool of mostly unattractive ones. We conclude with some observations on other practical challenges in using past returns to identify exceptional investment opportunities.

Keywords: Decision Making under Uncertainty, Risk, Utility, Risk Aversion, Coin Flip, Heuristics, Rules of Thumb, Market Timing, Gambling, Betting, Manager Selection, Sharpe Ratio, Mutual Funds, Data Mining

JEL Classification: B12, B16, B20, C00, C10, C11, C50, C57, C73, D03, D81, D83, E00, G00, G02, G11, G12, G14, G17, G23

Suggested Citation

White, James and Rosenbluth, Jeffrey and Haghani, Victor, What's Past is Not Prologue (April 1, 2017). Available at SSRN: https://ssrn.com/abstract=3034686 or http://dx.doi.org/10.2139/ssrn.3034686

James White (Contact Author)

Elm Partners ( email )

1630 Willow View Drive
PO Box 1417
Wilson, WY 83014

Jeffrey Rosenbluth

Elm Partners ( email )

1630 Willow View Drive
PO Box 1417
Wilson, WY 83014

Victor Haghani

Elm Partners ( email )

1630 Willow View Drive
PO Box 1417
Wilson, WY 83014

HOME PAGE: http://www.elmfunds.com

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