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Monday, June 30, 2008

I Feel Bryan Caplan's Pain

I have been known to criticize Bryan Caplan, and in fact I have a forthcoming mises.org hatchet job, er thoughtful critique, on him. But in this post he asked a simple question regarding the ability to profit from superior knowledge if futures markets don't go out far enough. And then Tyler Cowen gave a hand-waving appeal to authority that was a non-answer.

Arnold Kling dressed up Cowen's response, but check out the comments. JPC knocks Kling on his butt, then kicks him again when Kling tries to stand back up.

What must really be frustrating for Caplan is that these answers imply that Caplan hadn't thought of such obvious "solutions." Caplan purposefully rigged his initial scenario so that these obvious techniques wouldn't work.

I feel your pain, Bryan. The experts have been blowing me off for years too. Come join me, and together we can rule the blogosphere!

11 comments:

  1. Silas4:06 PM

    As you know, I can't post on Bryan_Caplan's blog, but my solution is this:

    The main assumption is false.

    "How can such valuable information be so useless?"

    Answer: it isn't valuable!

    In a world in which no futures contract for oil extends beyond 3 years, and no financial security's value tracks the price of oil more than that many years into the future, knowledge of the future price of oil in five years is not valued!

    Even though all those other traders would, in retrospect, like to have had this knowledge, no person actually values this knowledge presently. Therefore, the knowledge is not valuable.

    Do I win?

    ReplyDelete
  2. Hmm interesting view, Silas. Let's switch it to an easier case.

    Suppose you have just discovered a way to convert firewood into solid gold. But you can't convince anyone of your discovery. And you don't have any money with which to hoard firewood.

    Does that mean no waste is occurring before people realize you are right?

    I am torn between wanting to fully embrace subjectivism--resources only exist in the mind--and wanting to be able to non-tautologously praise the market for allocating resources.

    I think Selgin's thoughts on coordination (pdf)might be relevant here. (The relevant discussion starts on page 33 of the article, or page 15 of the pdf.)

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  3. Silas5:37 PM

    Bob_Murphy: Yes, there is waste, but it's the same as any other situation in which people are too stupid or short-sighted to realize a potential improvement that could be made.

    It's no different from me having majestic intelligence but not being able to persuade potential employers of it enough to hire me.

    Or how I can't connect with someone who will buy my new fuel-efficient car for close to what I paid, partly because I can't convince them of its functionality without losing a lot of money myself.

    I don't think it can work as an argument against a free or sorta-free market, thought. Any stupidity now, will exist in whatever other economic system proposed as an alternative. Even if the citizenry chooses to "be responsible" and place the "right" value on future resources, it just means they're putting random time discounts on resources that may or may not correspond to what the society in general, through revealed preference, places on those resources.

    So, Bryan_Caplan, you don't like how the world stupidly misvalues something? Join the f***in' club, dude.

    ReplyDelete
  4. But Silas, follow up comments showed that you can profit from that knowledge, e.g., short a basket of oil companies and go long on a basket of oil consumers.

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  5. Gene_Callahan: Correct me if I'm wrong, but Bryan_Caplan was asking for a pure arbitrage opportunity, not a statistical arbitrage opportunity. The ROR on a basket of oil consumers and oil companies is going to be blurred by other factors:

    -What other inputs/outputs they buy/sell.
    -Whether they choose to fundamentally retool based on oil expectations.
    -Whether they liquidate their assets and give the proceeds to shareholders in the expectation of these prices continuing.

    And of course, it all has to pay off and compensate the costs and risks of short-selling.

    Now, there may be a case that, averaged over the set of all possible outcomes, the expected value from that strategy is positive, but a) you don't believe in that conception of probability, and b) it would not be high enough to exceed Bryan_Caplan's risk inversion, at least if you include the wife term.

    ReplyDelete
  6. 'Gene_Callahan: Correct me if I'm wrong, but Bryan_Caplan was asking for a pure arbitrage opportunity...'

    Fine -- but that is irrelevant to the issue of whether or not the information is valauble. (I.e., it is not true that the only valuable knowledge is the knowledge of pure arbitrage opportunities!)

    ReplyDelete
  7. Poor Silas -- banned from so many blogs that he's been reduced to posting here!

    ReplyDelete
  8. Silas1:48 PM

    Gene_Callahan: That problem only persists if you equivocate. Yes, the knowledge of future prices is valuable in the sense of, "Hey, think it would good for people to agree with me about this," but is not valuable in the sense that "The market values it." And the market's "not valuing that knowledge" manifests in there being no pure arbitrage opportunities.

    ReplyDelete
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