Non-ergodicity and the poverty of kitchen sink modeling

13 March, 2018 at 11:21 | Posted in Statistics & Econometrics | 2 Comments

 

When I present this argument … one or more scholars say, “But shouldn’t I control for everything I can in my regressions? If not, aren’t my coefficients biased due to excluded variables?” This argument is not as persuasive as it may seem initially. First of all, if what you are doing is misspecified already, then adding or excluding other variables has no tendency to make things consistently better or worse … The excluded variable argument only works if you are sure your specification is precisely correct with all variables included. But no one can know that with more than a handful of explanatory variables.
piled-up-dishes-in-kitchen-sinkStill more importantly, big, mushy linear regression and probit equations seem to need a great many control variables precisely because they are jamming together all sorts of observations
that do not belong together. Countries, wars, racial categories, religious preferences, education levels, and other variables that change people’s coefficients are “controlled” with dummy variables that are completely inadequate to modeling their effects. The result is a long list of independent variables, a jumbled bag of nearly unrelated observations, and often a hopelessly bad specification with meaningless (but statistically significant with several
asterisks!) results.

A preferable approach is to separate the observations into meaningful subsets—internally compatible statistical regimes … If this can’t be done, then statistical analysis can’t be done. A researcher claiming that nothing else but the big, messy regression is possible because, after all, some results have to be produced, is like a jury that says, “Well, the evidence was weak, but somebody had to be convicted.”

Christopher H. Achen

the-only-function-of-economic-forecasting-is-to-make-astrology-look-respectable-quote-1The empirical and theoretical evidence is clear. Predictions and forecasts are inherently difficult to make in a socio-economic domain where genuine uncertainty and unknown unknowns often rule the roost. The real processes that underly the time series that economists use to make their predictions and forecasts do not conform with the assumptions made in the applied statistical and econometric models. Much less is a fortiori predictable than standardly — and uncritically — assumed. The forecasting models fail to a large extent because the kind of uncertainty that faces humans and societies actually makes the models strictly seen inapplicable. The future is inherently unknowable — and using statistics, econometrics, decision theory or game theory, does not in the least overcome this ontological fact. The economic future is not something that we normally can predict in advance. Better then to accept that as a rule ‘we simply do not know.’

Ergodicity is a technical term used by statisticians to reflect the idea that we can learn something about the future by looking at the past. It is an idea that is essential to our use of probability models to forecast the future and it is the failure of economic systems to display this property that makes our forecasts so fragile.

Roger Farmer

 

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2 Comments »

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  1. An oddly illustrative example of how econometric forecasting can fry the brain is the continued interest of U.S. Federal Reserve researchers in the yield curve.
    .
    Here is a link: https://www.clevelandfed.org/our-research/indicators-and-data/yield-curve-and-gdp-growth.aspx
    .
    For those of us anchored in the real world, the yield curve reflects a mechanism by which a central bank administering interest rates can induce a recession by triggering a contraction in credit and leverage. But, the astrologers at work in the in-house research hobby shops at Federal Reserve Banks make of it mumbo jumbo and esoterica. Their studies lead them to know less and less.

  2. […] Non-ergodicity and the poverty of kitchen sink modeling, larspsyll.wordpress.com […]


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