information asymmetry

That’s the fancy name for the situation where either you know more than the other guy or vice versa.  Think:  buying a used car, or competing in a game/sport with someone who has only half your experience and skill.

In investing, cases like the first are ones that everyone not an auto mechanics wants to avoid.  We should, however,be spending a lot of our research time seeking out the second type.

practice vs. academic theory

One of the odder things about financial theory taught in MBA programs is the professors’ insistence–despite overwhelming evidence to the contrary–that such situations don’t exist in investing.  Officially at least, they maintain that everyone possesses the same information.

There are several odd aspects to this state of affairs:

–professional investors are happy not to rock the boat, since, to the degree that students actually believe this stuff, business schools churn out large amounts of “dumb money” to be taken advantage of,

–if all market participants have precisely the same information, how is it an ethical enterprise to charge thousands of dollars a credit to inform students that they already know everything?

–in some deep sense, professors know they live in a Copernican world despite the fact they teach Ptolemy to get a paycheck.

When I was a student at NYU, the finance faculty had a number of eminent tenured theoreticians, as well as one semi-retired portfolio manager who was an adjunct teaching for fun.  One professor proposed a contest:  faculty members would each provide $10,000 of their own money into either a portfolio managed by the theoreticians or one managed by the adjunct “practitioner.”  Over, say, a year or two that would provide a practical illustration of the superiority of theory over vulgar practice.  Unfortunately, the test never got off the ground.  No one was willing to give real money to the professors; everyone wanted to back the working portfolio manager.

More tomorrow, on making information asymmetry work for you and me.