In his General Theory book, Keynes noted:

The difficulty lies, not in the new ideas, but in escaping from the old ones.

I mentioned this after having spent time this past week talking with professional economists.

While these individuals are nice and smart, it was clear there were enormous intellectual barriers to their acceptance of the Information Matrix.

Information Matrix

	Does Seller Know What They Are Selling?
Does Buyer Know What They are Buying?		Yes	No
	Yes	Perfect Information	Antique Dealer Problem
	No	Lemon Problem	Blind Betting

Specifically, I watched them struggle accepting the Blind Betting quadrant and its implications for much of economics and all of finance.

This occurred even after they acknowledged they engaged in blindly betting by buying investments based on their broker’s advice.

The old idea they had to exorcise here was the Efficient Market Hypothesis (EMH).  Under the strongest form of EMH, the market price reflects all available information because the insiders trade on it.  However, what if a security doesn’t have any insiders?  Then how does this information get incorporated into a security’s price?  It doesn’t.  The classic example of this is a structured finance security.  A mortgage-backed security is created by putting mortgage loans into a trust for the benefit of the investors.  Who is the insider here who would trade in the market?  The trust?

Their struggle deepened after acknowledging there were no research/journal articles written on the Blind Betting quadrant.  Can you imagine all those PhD economists and finance professionals missed it for several decades!!!

The old idea they had to exorcise here was the Blind Better quadrant wasn’t just another form of information asymmetry.

It is easy to show the Blind Betting quadrant isn’t another form of information asymmetry by using a physical model of a security.  In this case, the model is a paper bag in which I “put” a folded up $10 bill I borrowed from the economist.  I then ask what the value of contents of the paper bag was.  Naturally, the response was $10.  I proceeded to say I am an amateur magician and I needed to fold the bill in order to palm it.  Again, I asked what the value of the contents of the paper bag was.  The response was $0.  We then found a stranger and asked what they would be willing to pay for the paper bag that either had a $10 bill inside or nothing.  The stranger said $5.50.  I asked if the economist would accept the stranger’s offer for the contents of the paper bag.  Without hesitation the economist said yes because the stranger had offered more than the expected value.

I simply pointed out the economist had just engaged in a transaction in the Blind Betting quadrant.  Both the economist and the stranger had information about what might be in the paper bag.  Neither had information on what actually was in the paper bag.  Clearly, this is not another case of information asymmetry.

At about this time, there is a change to begrudging acceptance the Blind Betting quadrant exists.  Next up for the economists was trying to minimize its implications.

They couldn’t find an example of an area in finance where it wasn’t applicable.

They struggled to find an example of an area in economics where it wasn’t applicable.  Interestingly, the areas they could find where it wasn’t applicable, they saw as having other fundamental flaws.

I wasn’t surprised by their struggles.  After all, the Information Matrix forces each model used in economics and finance to answer the question:  does informed decision making yield a different result than blind betting.