Behavioral Finance: A Sneak Peak into OVTLYR’s Approach (Part 1)
The Wisdom of Crowds
In 1906, British scientist Sir Francis Galton attended a farmers’ fair where a contest was being held to guess the weight of an ox. Contestants ranged from professional livestock ranchers to inexperienced villagers. None of them guessed the correct answer, but when Galton averaged the nearly 800 guesses not only was the average better than any single entry – including those of cattle experts – it was also within 1lb of the 1198lb animal (99.92% accurate).
This is the “wisdom of crowds” phenomenon, where large groups offering independent diversity of thought may arrive at a more accurate estimate than even industry experts. As Aristotle pointed out in book III of Politics:
“It is possible that the many, no one of whom taken singly is a sound man, may yet, taken all together, be better than the few, not individually but collectively.”
The Foolishness of Herds
Not all crowds are wise. In James Surowiecki’s 2004 book The Wisdom of Crowds 5 key elements are necessary to differentiate between wise (and otherwise) crowds:
- Diversity of opinion.
Unfortunately, groups attempting to work collectively have a tendency to revert into herd mentalities, where an individual deemed an expert in the field is, either explicitly or implicitly, designated the “leader” of the herd. This hierarchy quickly dismantles the key elements of a wise crowd, as the group differs to the opinions of the leader to their own detriment.