Thursday, November 14, 2013

McDermott and Shleifer double-team Taleb and Kahneman

Not really. But I still enjoyed reading the following passage from Andrei Shleifer's review of Daniel Kahneman's (superb) Thinking, Fast and Slow:
The fourth assumption of Prospect Theory is quite important. [i.e. In assessing lotteries, individuals convert objective probabilities into decision weights that overweight low probability events and underweight high probability ones.] The evidence used to justify this assumption is the excessive weights people attach to highly unlikely but extreme events: they pay too much for lottery tickets, overpay for flight insurance at  the airport, or fret about accidents at nuclear power plants. Kahneman and Tversky use probability weighting heavily in their paper, adding several functional form assumptions (subcertainty, subadditivity) to explain various forms of the Allais paradox. In the book, Kahneman does not talk about these extra, assumptions, but without them Prospect Theory explains less.  
To me, the stable probability weighting function is problematic. Take low probability events. Some of the time, as in the cases of plane crashes or jackpot winnings, people put excessive weight on them, a phenomenon incorporated into Prospect Theory that Kahneman connects to the availability heuristic. Other times, as when investors buy AAA-rated mortgage-backed securities, they neglect low probability events, a phenomenon sometimes described as black swans (Taleb 2007). Whether we are in the probability weighting or the black swan world depends on the context: whether or not people recall and are focused on the low probability outcome. [Emphasis mine.]
This exactly the issue I was trying to point out here. Sometimes people greatly overweight the risks of low probability events (as suggested by Kaheman and Prospect Theory)... other times they completely underestimate them (as suggested by Taleb's black swan metaphor). As a result, we should be cautious in trying to make generalisable statements about human behaviour from either one of these theories alone.

You may also recall that -- for my temerity in pointing out this apparent tension between Kahneman and Taleb's theories -- I was labelled an "idiot" by none other than Taleb himself. As I coyly suggested in that second post, Taleb's affinity for labelling others as idiotic meant that I was at least likely to be in good company. I am sure of that now having read Shleifer's article.

Wednesday, November 6, 2013

Why economists love auctions

Some background first: South Africa's power market is utterly dominated by (a) coal and (b) Eskom, the parasitical parastatal monopoly. In a bid to encourage both fuel diversification and competition, the government has determined that 3,725 MW of new capacity up until 2030 should consist of renewable sources operated by independent power producers (IPPs). This translates to roughly 10,000 GWh of actual future electricity generation.

Ignoring the fact that this is small potatoes in the scheme of things -- less than 5% of the country's current 240 TWh annual electricity consumption -- the point that I want to make here is mostly about how those IPPs are chosen.

Having played with various schemes, authorities eventually settled on something called the Renewable Energy Independent Power Producer Procurement Programme (REIPPPP). This is effectively a competitive bidding process, whereby applicants submit a guaranteed price that they are willing to accept for electricity that they generate in the future. In other words, it looks a lot like the idealised auction market advocated in economic textbooks.

So how have things turned out? Well, the results from the third round of bidding have just come in. (The previous bidding rounds were held in 2011 and 2012, respectively.) It would appear that things are progressing rather well:
The six successful solar PV bidders, which shared an allocation of 435 MW, were particularly aggressive with their pricing. Fully indexed prices using April 2011 as the base year showed that the average solar PV price fell from R2.75/kWh in bid-window one to 88c/kWh in the third round.
[...]Similarly, the price of onshore wind fell from R1.14/kWh in round one to 89c/kWh in round two and to only 66c/kWh in the latest round. A total of 787 MW was allocated across the seven wind projects
[...]Prices for the two 100-MW-apiece CSP [concentrated solar power] projects declined from R2.68/kWh in the first window to R1.46/kWh. 
We must of course be careful not to draw too many conclusions from the above figures. For one thing, the average price that South Africans currently pay for electricity remains lower than any of the above bids. Although, it is scheduled to approach (and even exceed, in the case of wind) them in coming years:

Even then, just because a small portion of wind or solar energy is expected to "reach grid parity" within the next five years, doesn't mean that the game is up for fossil fuels. There are major problems with peak balancing, intermittency and load-following constraints that renewables need to overcome, which I and many others have discussed at length before.

However, a 68% drop in the bid price of solar PV since 2011 -- say nothing of wind and CSP bids falling by nearly 45% -- is clearly impressive. Many people will see this as a evidence of how quickly renewable technologies are progressing. I wouldn't dispute that, but I also see it as a vindication of the auction system that was used for determining the winning bids.

It is something that South Africa's electricity sector could use a lot more of.

Bad science: Paleo diet edition

A while ago, I wrote a post praising the scientific approach that advocates of the paleo diet appeared to be adopting in arguing their case. In particular, the language used by people like Gary Taubes in discussing dietary health seemed to show a keen appreciation for the key principles underpinning the scientific method. This includes separating causation from correlation, controlling for placebo effects and selection bias, etc, etc.

However, apparently not all paleo advocates are such sticklers for good scientific practice. For example, see this blog post by Jacques Rousseau, which skewers a new "occasional study" by Tim Noakes.[*] There is a lengthy follow-up post that also well worth reading when you have time.

The short version is that Noakes is a very prominent sports scientist in South Africa. He also happens to be an extremely vocal proponent of the low-carbohydrate-high-fat (LCHF) paleo diet, having undergone a Damascene conversion in recent years. The occasional study in question was published in the South African Medical Journal and details 127 unsolicited responses that Noakes received from people who have followed his advice in switching over to LCHF. These correspondences tell of all manner of dietary miracles and health wonders that have followed as a result, from substantial weight loss to curing "incurable" diseases like type II diabetes.

The problem with this study should be all-to-obvious to anyone who understands anything about scientific practice -- more on that in a minute.  Furthermore, a lot of people are (rightly) up in arms about how it managed to get through the peer-review process and into the country's flagship medical journal. Cynical observers have not been shy in suggesting that this is almost entirely down to Noakes' status within the local research community and very little to do with the scientific merit of the study itself. (To be fair, I'm not sure that a double blind submission would have been possible in this case.)

Now, Jacques does a very good job in explaining the manifold problems of the study. He also points out that Noakes' position on the necessity of such anecdotal evidence is very inconsistent. (If we had proper, scientifically validated evidence about the benefits of LCHF then we wouldn't require anecdotal evidence on top of that. To argue otherwise is to suggest that the scientific evidence in favour of LFHC is not actually particularly strong.) However, I think some of the commentators actually do a better job of pinpointing exactly why this study does not belong anywhere near a reputable scientific journal. For instance, "Chris" writes:
[...]You could prescribe or promote absolutely anything, and you would see some people benefit. The key point is that the sample you have is self selected from those who benefited enough that they felt the need to contact you. That is likely to be a small number of the total number of people who did indeed benefit. And we have no idea what proportion of the total number of people to have tried LCHF those people are. The fact that there are 127 people who've shown a benefit is evidence of one thing, and one thing only: those people's ability to write you an email. Can you tell me exactly what their dietary regimes were, down to the last macronutrient? Can you assure me that the change in their diet was not simply a catalyst for them to become more active, thus they expended more energy? Can you tell me that there were no other outside influences that could potentially act as a confounding variable? You can't, and you say so yourself in the article. Which begs the question of why did it get published? If we can't say anything other than these people got amazing results and said they were on LCHF then what exactly can we say?[...]
Emphasis mine. A follow-up contribution by another commentator (who was actually involved in one of the cases that Noakes cites) is equally worth reading here.

To underscore something that Jacques and many of his commentators try to make abundantly clear; criticism of this particular study does not amount to criticisms of LCHF in of itself. The outcry is entirely about sloppy scientific reasoning and misuse (absence?) of the scientific method. Proponents of LCHF and other paleo-style diets may well be correct in identifying the causes of our modern dietary ills. I personally know more than a few people who credit it with helping them to shed weight and improve their overall sense of well-being. On the other hand, I can say exactly the same thing about friends who have converted to veganism. (You see the problem with anecdotal evidence!)

To conclude, if paleo advocates want to maintain scientific credibility, they need to distance themselves from this type of research. At the very least, they should not try to defend it.
[*] You may recall that I actually mentioned Prof. Noakes at the beginning of my previous post. Rousseau is a senior lecturer at the University of Cape Town, whom it should be said took me for an introductory philosophy and business ethics course during my undergrad.