The Investor's Shelf — one book
The Wisdom of Crowds: Why the Many Are Smart

The Wisdom of Crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies and Nations

James Surowiecki
2004
T4 328 pages · about 5h 28m to read OL8036447Wgoodreads

Summary

Surowiecki argues that aggregated judgments from many people frequently outperform the judgment of experts, and specifies the four conditions required for this to hold: diversity of opinion, meaning members hold different private information; independence, meaning their judgments are not determined by others; decentralisation, meaning they can draw on local and specific knowledge; and aggregation, meaning a mechanism exists for combining the judgments into a collective one.

His opening example is Galton's 1907 observation that the median guess of nearly eight hundred people at a cattle weight was within one pound of the correct figure. He extends this to markets as aggregation mechanisms, to the search for the missing submarine Scorpion, and to prediction markets.

He divides problems into cognition problems with a definite answer, coordination problems where each participant must anticipate others, and cooperation problems requiring self-interested people to work together, and analyses each separately. The second half examines failures. When independence is lost, information cascades produce herding, in which each participant rationally follows the previous ones and the aggregate information disappears. He covers the Columbia shuttle disaster, stock market bubbles and committee dynamics as cases where the conditions failed.

The conditions are the book's contribution, since they specify when crowd judgment works and when it fails, which is the part most often dropped in popular use. The book is journalism rather than research and the cases are selected. The independence condition has become harder to satisfy as social platforms have made judgments visible before they are formed, which strengthens the book's warning rather than its optimism.

Key takeaways 8

  1. Aggregated judgments from many people can outperform experts, but only when four specific conditions hold.
  2. The conditions are diversity of private information, independence of judgment, decentralisation permitting local knowledge, and a mechanism for aggregation.
  3. When independence fails, participants follow each other and the aggregate stops containing any new information.
  4. Information cascades occur when each participant rationally infers from previous choices, which produces herding without anyone behaving irrationally.
  5. Adding more informed people to a group can reduce accuracy if it reduces diversity, because correlated errors compound.
  6. Markets function as aggregation mechanisms and fail when their participants stop forming independent judgments.
  7. Cognition problems, coordination problems and cooperation problems have different requirements, and the crowd result applies most cleanly to the first.
  8. Small groups can be worse than individuals, because deliberation produces convergence and amplifies the errors that members share.

Who should read it

Operators designing forecasting and decision processes who need to know when aggregating judgments helps and when it produces correlated error.

Where it sits in the reference 2

Philosophy
Mental models

Who recommended it 5 · 2 direct

Contrarian Investing: The Psychology of Going Against the Crowd (Legg Mason Capital Management)
“Jim Surowiecki deftly articulated this line of thinking in his delightful book, The Wisdom of Crowds.”
Chai with Pabrai bookshelf — Unorganized, yet Interesting
Ev Williamsreported
Book recommendations listed on their Good Books profile · aggregator only
Kevin Rosereported
Book recommendations listed on their Good Books profile · aggregator only
Simon Sinekreported
Book recommendations listed on their Good Books profile · aggregator only

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