Friday, May 16, 2008
Bubbles vs. Non-Bubbles: science of prognostication
Bubbles vs. Non-Bubbles Thought experiment: imagine you had a magical device, hooked up to a klaxon, that rang out before the market bubble burst. But, when it rang, you didn't know if the bubble would burst in 5 seconds, or in 3 months. It had some randomizer inside, and you didn't have access to know the setting. There are some unknown number of such devices held by other investors. Maybe a dozen, maybe hundreds, maybe thousands. Each has a reason to keep the existence of their ownership of the device a secret. You are waken at 3 A.M., by a terrible ringing. What do you do? Every second you wait, after the klaxon rings, before the bubble actually bursts, you are making money. How long after the klaxon rings, do you pull the trigger? The point is, even with this magical device, there would be a temptation to procrastinate on selling your whole position, there would be a temptation to try to time the market to the second. Somebody, in possession of this wonderful device, will get caught with their pants down. How the hell will this supposed science of bubble prognostication be any better than this magical device? It can only be worse, with worst results.