Keynes: reasoning with probability

What is probability?

Probability is the study of the grounds which lead us to entertain a rational preference for one belief over another. That part of our knowledge which we obtain directly supplies the premisses of that part which we obtain by argument. All propositions are true or they are false. Probability refers to a relationship with a corpus of personal knowledge, actual or hypothetical, and not to a characteristic of the propositions themselves. As our hypotheses change, our conclusions will have new probabilities, but relatively to these new premisses. It is the degree with which it is rational to entertain a belief that a particular proposition is true based on our – subjective – knowledge, our intuition: we know that proposition so-and-so bears a relation with a degree of probability such-and-such to the corpus. Such a probability is determined through the objective application of logical rules of inference, upon which arguments can be based and which can be perceived, between the propositions of our direct knowledge and our indirect knowledge. → Read More

Hume on mind and probability

Ideas and impressions

The outside world as we know it derives from our inner imagination. The impressions the senses convey form the basis of all our beliefs and our actions. To hate, to love, to think, to feel, to see; all this is nothing but to perceive. All of the sciences are thus related, to a greater or lesser extent, to human nature. → Read More

Is it worth the wait?

A company decides to invest in, say, an additional production line if the expected profit exceeds costs. In other words, the expected rate of return must exceed the company’s cost of capital. That is the theory, at least: fifty years ago.

In practice entrepreneurs have known for quite some time that the threshold to invest is markedly higher. According to a survey by former US Secretary of the Treasury Lawrence Summers CEOs discount project cash flows at rates amounting to three times the weighted average cost of capital!

Inversely, companies terminate loss-making projects only — and correctly — when revenue is far below (variable) costs. Textbook investment theory apparently deviates from entrepreneurial practice. Which crucial issue has been ignored? → Read More