The Difference Between Risk and Uncertainty

This piece by Ben Hunt, The Three-Body Problem, is very good. It starts with fascinating insights into how bees prepare for and survive winters in the northeastern US where Ben lives.

My notes from Ben’s piece are below:

One must understand the difference between risk and uncertainty

Risk is when you have a decent sense of the odds and payoffs. You can apply statistical methods to these decisions, especially when you will be able to make this decision many times.

Uncertainty is when you do not have a good sense of the odds and payoffs. In this case, relying too much on statistical models could kill you, especially if you don’t know how many chances you have or the number of chances is limited. In this situation, game theory needs to be incorporated.

The Three-Body Problem

This is when it is impossible to predict where three variables will be in the future using algorithms that look at the variables’ history. Instead, your only chance of approximating where they will be in the future is by solely looking ahead.

Today, a characteristic (e.g. high-quality company) leading to better performance in that company’s stock is overwhelmed by the actions of a third variable: the monetary policy of central banks.

One’s best strategy in this scenario is to diversify across geographies and asset classes, and, instead of attempting to maximize return, seek to minimize maximum regret (‘minimax’). Each person’s minimax regret is subjective. For some, it might be financial ruin. For others, it may be earning a lower return than their peers.

                It’s important to not rely on computer algorithms to make our decisions during this stage. We’re hardwired pattern-seeking machines, but we must think beyond that. Be humble in knowing we will never understand how a chaotic system like this works, but we can approximately try.

It’s tough to resist The Answer because we want there to be an all-knowing, all-useful solution. Closed-form solutions like this don’t exist though.

Ben Falk on Building NBA Teams and a Winning Culture

Ben Falk started working for the Portland Trail Blazers as an analytics expert while he still had two years of college left to finish. After graduating, he spent several years each with the Blazers and the 76ers assisting with analytics and basketball strategy. Today, he posts what he’s seeing in the league on his site Cleaning The Glass.

Zach Lowe had Falk on his Lowe Post Podcast this week, and Falk had many insightful things to say about constructing teams in the NBA along with winning strategy in today’s game. My notes are below:

— Zach Lowe’s solid insight on franchises that try to be good now while also adding young prospects to develop to be good in the future: It seems easier to be good first, and then worry about building assets to drive the future. Being mediocre to poor now and then trying to build from scratch has choppy results historically.

Falk’s related point: People like to say culture creates winning. But a lot of times winning creates culture. It’s hard to have a good culture when you’re losing.

— When projecting a draft pick, you have to consider their potential in terms of a probability distribution. What is the chance they become a star? A starter? A role player? A bust? And you’re constantly adjusting those odds as more information arrives. New info can make a big difference at the extremes (whether they project to be a star or a bust), which shrinks the potential outcomes.

And your expectations about the prospect at the start affects those predictions. If they’re high, you’re more patient with a slow or disappointing start than you would be if you’re taking a flyer on a pick at the end of the draft. Also, if you know this player will take time to develop, you’re more willing to wait.

Think about all the abilities a player has and what is more likely to change than not. Shooting is easier to change than height or hoops IQ.

— Ultimately, decisions rarely are black and white. You should rarely go into a decision thinking 100% one way or the other.

One franchise grades every one of their transactions on a scale of 1-100 of whether they think each one will work out. It makes you consider your threshold for making a deal. Does it have to be a 60? An 80? A 90? That said, uncertainty is not an excuse for inaction.

— It’s easy to have your goals set by outside influences. You have to set internal goals.

Sam Hinkie was incredible at having consistency internally. He ignored any talk of what he’d have to do to save his job, because that’s how terrible decisions get made.

The best trade Ben was a part of (trading Gerald Wallace for the draft pick that became Damian Lillard) occurred because of the other team’s desperation.

— Sam Hinkie quote: “Every game is a data point.”

— In Philadelphia, they made players earn the green light to shoot certain shots in the game by hitting a certain percentage in practice.

— In the NBA, it’s amazing how much a foot or a step matters. It can be the difference between being in position to challenge a shot vs. giving up a layup.

— It’s tough to have a great offense without getting at least some easy points from transition and/or putbacks.