Know What?
We're often told that knowledge is power. However, in reality, knowledge may be unexploitable leading to the paradoxical situation that high quality goods get overpriced and low quality ones underpriced. Insiders, it turns out, are often burdened by the curse of knowing too much.
Part 3 of 101 Ways To Lose Money
Curse
The curse of knowledge is related to hindsight bias, the problem being that if we have expert knowledge about something - the real value of a security for instance - we can't put ourselves in the position of uninformed punters. I experienced this personally during the dotcom era when I resolutely refused to invest in a whole bunch of IT companies that I knew for a fact were a complete crock.
The result, naturally, was that everyone I knew who didn't have my inside knowledge made a ton of money and I didn't. Bah.
Asymmetric
Classically insiders with expert knowledge are supposed to have an edge on naive outsiders. However, the curse of knowledge mitigates against this. We simply cannot un-know information, we're unable to put ourselves back in the state of not knowing and therefore are unable to put ourselves in the position of uniformed parties.
In one brilliant, but sadly unpublished piece of research (1) participants were asked to tap out the rhythm of a bunch of songs and then estimate how many listeners would be able to guess. The tappers guessed 50%, the listeners managed 2.5%. It's why no one ever gets your brilliant charade mimes.
Think Like An Outsider
The curse of knowledge is related to hindsight bias, the problem being that if we have expert knowledge about something - the real value of a security for instance - we can't put ourselves in the position of uninformed punters. I experienced this personally during the dotcom era when I resolutely refused to invest in a whole bunch of IT companies that I knew for a fact were a complete crock.
The result, naturally, was that everyone I knew who didn't have my inside knowledge made a ton of money and I didn't. Bah.
Asymmetric
Classically insiders with expert knowledge are supposed to have an edge on naive outsiders. However, the curse of knowledge mitigates against this. We simply cannot un-know information, we're unable to put ourselves back in the state of not knowing and therefore are unable to put ourselves in the position of uniformed parties.
In one brilliant, but sadly unpublished piece of research (1) participants were asked to tap out the rhythm of a bunch of songs and then estimate how many listeners would be able to guess. The tappers guessed 50%, the listeners managed 2.5%. It's why no one ever gets your brilliant charade mimes.
Think Like An Outsider
The curse of knowledge can have paradoxical effects, because if insiders know more than outsiders then they're likely to set prices according to their inside knowledge, rather than on the basis of what a dumb outsider would. This can help alleviate information asymmetries, which are normally expected to benefit the insider (2).
The solution to this, obviously, is to try to put yourself in the position of outsiders and to set prices based on that lack of knowledge. Sadly this is nearly impossible, which why knowledge is a curse: we can't unlearn stuff we're learned: until you've learned a language it's just unintelligible noises, but once you know it you can't stop your brain interpreting.
Stay Rational
The solution to this, obviously, is to try to put yourself in the position of outsiders and to set prices based on that lack of knowledge. Sadly this is nearly impossible, which why knowledge is a curse: we can't unlearn stuff we're learned: until you've learned a language it's just unintelligible noises, but once you know it you can't stop your brain interpreting.
Stay Rational
So if you know a stock inside out, and understand all of the implications of that information, even to the point of absolutely knowing that you're looking at the bargain of all time, don't expect everyone else to appreciate you. If you're right then eventually the numbers will prove you correct, but remember that the market can stay irrational for a long, long time.
Curse of Knowledge added to the Big List of Behavioral Biases
Links: hindsight bias, information asymmetry
Research:
- Newton, L. "Overconfidence in the Communication of Intent: Heard and Unheard Melodies", Unpublished doctoral dissertation (Stanford, CA: Stanford University, 1990
- The Curse of Knowledge in Economic Settings: An Experimental Analysis
Related Posts:
No comments:
Post a Comment