Having talked with several economists and finance professors, it is clear my presentation of the Information Matrix in Transparency Games and subsequently on this blog was too complex.
So I am going to try again. Below is the Information Matrix:
| Does Seller Know What They Are Selling?
Does Buyer Know What They are Buying?
Seller Wary of Being Taken Advantage Of
|No||Lemon Problem||Blind Betting|
The matrix is the result of asking two questions.
- Does the buyer know what they are buying? Either the buyer has access to all the information they need to make an informed decision (Yes) or they don’t (No).
- Does the seller know what they are selling? Either the seller has access to all the information they need to make an informed decision (Yes) or they don’t (No).
The answer to these questions produces the four cells in the matrix I would like you to focus on in the lower right corner.
- Perfect information. The condition under which perfect information occurs is when both buyer and seller have access to all the information they need to make a fully informed decision. This is the necessary condition for the Invisible Hand of the Market to operate properly. It is also the fundamental assumption underlying all of Economics.
- Lemon Problem and Seller wary of being taken advantage of. The condition under which either of these occurs is when there is information asymmetry. The Economics profession has undertaken a significant amount of work on information asymmetry. The Lemon Problem was laid out by George Akerlof and describes the case when the seller has more information than the buyer. The classic example of this is the sale of a used car. The seller knows more about the mechanical condition of the car than the buyer. Joseph Stiglitz laid out the case for when the buyer has more information than the seller. The classic example of this is the sale of an antique to a person in the business of buying antiques.
- Blind Betting. The condition under which blind betting occurs is when both buyer and seller do not have access to the all the information they need to make a fully informed decision. Prior to my publishing the Information Matrix, there was no work on this condition by either economists or finance professionals. Some might ask why there have been no academic studies especially considering it is exactly when both buyer and seller are blindly betting that Wall Street maximizes its profits. The classic example of blind betting is the sale and resale of structured finance securities and related derivative products like subprime mortgage-backed deals. By design, these securities are opaque. So the deals were impossible for the original purchaser to value when they bought the deal or when they try to sell the deal in a secondary market. The continued opacity of the deals also makes it impossible for any prospective buyer to value the deals. Hence, when a secondary market transaction occurs, it is pure blind betting by seller and buyer. Did secondary market transactions occur in the run-up to the financial crisis in 2007/2008? Of course they did. They are still happening today even though neither buyer or seller knows the value of what they are buying or selling.