WHY DID ADMIRAL POINDEXTER WANT AN INFORMATION MARKET?

Managing Uncertainty (Jim Surowiecki, January 22, 1997, Motley Fool)

We live in a world in which events -- whether they be jumps in the price of Microsoft or blizzards in the Midwest or Super Bowl victories for the Cowboys -- are caused by certain things and not by others. The nature of those causal relationships, though, often remains obscure. We may feel comfortable drawing some conclusion about the market from a rise in Microsoft's stock price, but we would probably feel much less comfortable saying that one thing had caused that rise.

More importantly, even if we can state with some certainty why something happened, that leaves us a long way from being able to state with similar certainty what will happen. We can read the past for portents of the future, but we can never be sure that we're looking at the right evidence, which is just another way of saying that we can never be sure we're looking at the right past. Those disclaimers at the bottom of mutual fund ads are not, in the end, there simply to keep the funds from getting sued. Past performance is no guarantor of future performance, either for the market or for money managers. Things change. Things always change.

The problem, then, is that we want -- and have -- to make decisions about the future, but we do so without perfect knowledge. Peter Bernstein's new book, Against the Gods: The Remarkable Story of Risk, takes on this problem by constructing a kind of history of risk management. [...]

In a curious way, in fact, Bernstein has written a history of risk management that ends by leaving us more aware than ever of the impossibility of fully managing risk or comprehending the workings of complex systems. There's always something just beyond our grasp, something of which we will be unable to make sense. Risk itself, after all, is the product of uncertainty. That said, some risks are better than others.

How, then, can one know which risks are better? We can take a pretty good stab at predicting, for example, where the Dow Jones Industrial Average is going to be in five years, and we can base that prediction on specific reasons. If we could actually foresee those reasons and those results, we could either make an enormous amount of money or protect ourselves against losing an enormous amount of money. Bernstein quotes a fund manager's thoughts about information as it pertains to investing:

The information you have is not the information you want.

The information you want is not the information you need.

The information you need is not the information you can obtain.

The information you can obtain costs more than you want to pay.

But sometimes the information you have is precisely the information you need, and sometimes the information you can obtain is priced perfectly, and you catch a glimpse of what the market is going to do.

The problem is that you don't know you've caught a glimpse until after it's all over. The hope is that the more information you have, the more work you do, and the better attuned you are to the underlying realities of the businesses in question, the better your chances of prediction.

Listening to the various Senators bloviate about the terrorism market today was even more painful than usual. On the one hand, these guys want the national security agencies to produce better information to protect against terrorist attacks. On the other, introduce a new but not even innovative means of generating that information and they squeal like stuck pigs. Makes it awfully hard to take them seriously. Posted by Orrin Judd at July 29, 2003 8:09 PM