New video explains the danger of selection bias in finance

A new video has been produced by the Mathematicians Against Fraudulent Financial and Investment Advice (MAFFIA) group. It explains, in simple terms, how many of the financial strategies and funds available today are based on a statistically dubious foundation, typically rooted in selection bias effects, because the finance world, unlike other fields such as the pharmaceutical industry, has not yet been forced to adopt the necessary rigorous statistical methodology to prevent such problems.

As a result, we often see a “vicious cycle”:

  1. Academic researchers publish a paper describing a new investment strategy, but fail to disclose the fact that they had simulated millions of parameter combinations, but only published the best one.
  2. The researcher receives accolades for the work, in terms of publications, tenure or, possibly, an award.
  3. A financial firm or advisor reads the paper and constructs a financial product (strategy or fund) based on this research, promoting it to clients as “scientific” and based on published academic studies.
  4. Customers large and small invest in the scheme, relying on the advice of the financial firm or advisor.
  5. After a while it becomes clear that the resulting performance is disappointing, or even results in a serious loss, but in the meantime those responsible have moved on to new strategies and programs, and the cycle repeats.

Fortunately, tools are now available to prevent this vicious cycle, as the video explains.

The video is available here:

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