On the Difference between Binary Prediction and True Exposure, with Implications for Forecasting Tournaments and Prediction Markets – By Nassim Nicholas Taleb and Philip E. Tetlock
There are
serious differences between predictions, bets, and exposures that have a yes/no
type of payoff, the "binaries", and those that have varying payoffs,
which we call the "vanilla". Real world exposures tend to belong to
the vanilla category, and are poorly captured by binaries. Vanilla exposures
are sensitive to Black Swan effects, model errors, and prediction problems,
while the binaries are largely immune to them. The binaries are mathematically
tractable, while the vanilla are much less so.
Hedging vanilla exposures with binary bets can be disastrous--and
because of the human tendency to engage in attribute substitution when
confronted by difficult questions, decision-makers and researchers often
confuse the vanilla for the binary.
