With superforecasters in and out of 10 Downing Street and the imminent publication of “Radical Uncertainty” by economist John Kay and former governor of the Bank of England, Mervyn King, it seems a good time to talk about prediction.
Radical Uncertainty argues that contemporary approaches to dealing with uncertainty rely on a false understanding of our power to make predictions, leading to many of the problems we experience today. My copy is on order and I can’t wait to read it.
I suspect that Kay and King will not have dedicated part of the book to discussing circular references in financial models. However, a large proportion of circular references are caused by crystal ball gazing and precisely that false understanding of our power to make predictions.
Whilst of course financial modelling is all about projections, there is a subtle difference between estimating the future and knowing the future. If you think you know the future, then Excel will helpfully tell you that you have a circular reference and therefore that you are being illogical. Rather than thinking up an excuse and fixing it through macros or iterations, take Excel’s warning seriously and work out the problem with your logic.
Despite what we may be told by economists or the media, of course we can’t know the future. We can guess, we can run sensitivities but ultimately there is no certainty. We can only arm ourselves with facts and apply common sense and good judgement.
Remember that in life and in models there simply is no crystal ball gazing and no time travel. And remember the words of Pliny the Elder 2,000 years ago: “The only certainty is that nothing is certain.”