Economics · Humor · Philosophy

The Paradox of Accurately Predicting the Stock Market

Let’s make believe that a very smart person named Alice creates a method of accurately predicting the stock market. Maybe this method is a formula or an algorithm that eats certain inputs and spits out an output or maybe it is something else entirely. The important thing is that it tells her the ups and downs of the stock market a day, a week, a month, or a year from now.

This thought experiment allows for the method to work perfectly whenever Alice does not purchase or sell stocks based on what the data that the method gives her. That’s fine and dandy. The only controversial thing about this is that it presupposes that the stock market can be dependably predicted in the first place. And we were already presupposing that.

Alice simply records the data that the method gives her and waits to see if reality matches what she has. This isn’t paradoxical so for. Alice is in the same position as an all knowing god outside of the universe who is watching the world unfold exactly as the god knew it would unfold (ignoring any paradoxes that comes with omniscience).

But what happens if Alice starts to buy and sell stocks based on her predictions? Will she become rich? Or will her actions totally screw up the predictions? It’s difficult to imagine how such a prediction method could take someone acting on information from the method into account. How could it? Maybe Alice’s actions do change how accurate the predictions are but only to such a small extent that the predictions are still good enough to benefit Alice. After all, the input of just one person won’t completely change the stock market right? Maybe. Maybe not.

Finally, what if Alice releases her method to the world? We must also pretend that Alice is credible enough for the world to take her work seriously. Let’s say she does and all the experts review it and agree that it does accurately predict the stock market, at least in the case that nobody acts on the information that it gives.

But what happens when everyone in the world has access to a way of knowing the best actions to get rich on the stock market? Does everyone get rich? Well, that certainly makes my BS detector go off. It goes against my basic intuitions about economics. If everyone doesn’t get rich, can we say the method is any good at predicting.

This is the paradox. It looks like the only way this method is guaranteed to work is to never even use the thing. But would it be useful for just one person if that person never touched the stock market? Maybe. Maybe it would important economic truths. But for Alice to reveal these economic truths to the world, she would have to demonstrate it without using the method in order to be credible.

The spooky thing is that someone might have already done this. I would look for the economist who is pumping out good, credible economics papers left and right. That person has the method! If that person does exist, then he or she is quite the benevolent keeper of the method. There is so much power in such a method. If it were released to the world, then who knows what would happen.

Could this benevolent keeper be proactive? Suppose this method reveals that an economic crash will happen? Would the benevolent keeper have the means to save the economy and millions of lives? I would hope so. Another spooky thing is that this might be the one case where releasing the method would be the smart thing to do. In the face of certain disaster, why not introduce some uncertainty? It might save the world.

If you’re out there, benevolent keeper, make sure to follow me on Twitter @realKeeGeeK. Also, thank you! You’re doing the world more good than you know.

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