(2020-07-31) Pearson Ergodicity

Taylor Pearson on Ergodicity. (see also this)

Some interesting research is being done on this topic by Ole Peters and the London Mathematical Laboratory that culminated in a paper in the Journal Nature last year called The Ergodicity Problem in Economics. At the risk of being hyperbolic, I think it is one of the most important papers I’ve ever read and I have sent it to roughly a gazillion people so, in the interest of disseminating some of the ideas, I wanted to write a non-technical summary here.

a pretty simple way to identify an ergodic situation is to ask do I get the same result if I: Look at one individual’s trajectory across time; Look at a bunch of individual’s trajectories at a single point in time. If yes: ergodic; If not: non-ergodic

In practice, pretty much all economic decisions are non-ergodic. You only have one career and one investment path, but we often don't think about this way.

A lot of economic and investment theory is predicated on a major error: it assumes most economic games are ergodic, but they aren’t.

To make an economic or investment decision, I want to know how my personal fortune grows or shrinks under different scenarios, not how the average person’s fortune grows or shrinks.

many “biases” disappear when you realize that people intuitively understand ergodicity

The way traditional economics deals with this paradox is by ascribing this human behavior to “irrational biases” and expected utility theory.

According to this thinking, an “aggressive” or “brave” investor would be willing to participate in Russian Roulette, whereas a “conservative” or “scared” investor would not.

Ergodicity economics starts from a different premise: individuals should optimize for growth rate over time, not across many people.

*Ergodicity economics suggests that it is not so much that some people are more aggressive or conservative, it’s that people behave differently depending on the game they are playing.

This is supported by an experiment in which a group of neuroscientists from Copenhagen split participants into two groups. On Day 1, the participants played a multiplicative game (less ergodic). On Day 2, the exact same participants played an additive game (more ergodic).*

In practice, most of the economic games we play from career choices to investment choices are multiplicative and so it is not that many people are too “risk-averse” or “conservative” because of some psychological bias, it is that when you are maximizing your own long term wealth, you should be just as worried about the downside as the upside.