{"id":877,"date":"2009-09-29T11:54:15","date_gmt":"2009-09-29T15:54:15","guid":{"rendered":"http:\/\/mat.tepper.cmu.edu\/blog\/?p=877"},"modified":"2009-09-29T11:54:15","modified_gmt":"2009-09-29T15:54:15","slug":"models-information-and-market-rationality","status":"publish","type":"post","link":"https:\/\/mat.tepper.cmu.edu\/blog\/index.php\/2009\/09\/29\/models-information-and-market-rationality\/","title":{"rendered":"Models, Information, and Market Rationality"},"content":{"rendered":"

I have come across a couple of items recently involving market rationality and the ability of the market to reflect “unknown” information.\u00a0 The first came in a conversation with my colleague Bryan Routledge<\/a>.\u00a0 Harkening back to the Challenger disaster<\/a>, Bryan mentioned that “the market” quickly determined the company that caused the failure (all this is my paraphrasing of my understanding of what Bryan said:\u00a0 it is my fault if it is wrong!).\u00a0 Here is the graph of the stock prices of the main companies involved in building the space shuttle on the day of the disaster:<\/p>\n

\"shuttle<\/p>\n

There are four companies shown:\u00a0 Morton Thiokol, Lockheed, Martin Marietta, and Rockwell.\u00a0 The stock price for all of the companies immediately dropped 7-8% after the disaster.\u00a0 Within an hour, three companies went back up to being just 2-3% down, while one company further decreased:\u00a0 Morton Thiokol.\u00a0 The company responsible for the O-ring (of Richard Feynman and ice water fame):\u00a0 Morton Thiokol.\u00a0 It is certainly provocative that the market seemed to know something immediately that took an investigation months to determine. It would have been even more impressive if the market identified this an hour earlier (the explosion happened at 11:39AM), but the results from the day are still pretty impressive.<\/p>\n

But, as Bryan reminds me, this was not exactly a mystery to everyone<\/em> at the time:\u00a0 the engineers involved strongly suspected early what the issue was and later fed that information to Feynman.\u00a0 So the information was out there and perhaps that information leaked out to the market in the immediate aftermath of the explosion. So perhaps it is not so mysterious after all. And there may well be other explanations for the larger drop off by Motton Thiokol.<\/p>\n

Continuing the theme of markets seeming to have information that mere mortals do not, Panos Ipierotis, with tongue-in-cheek, suggested a prediction market on the P=NP question<\/a>, arguing<\/p>\n

\n

So,if P=NP is a decidable problem, it is either true or false. So, a fully rational<\/em> agent, participating in the market, should know<\/em> whether P=NP. It is not a matter of probabilities! All the information to make the decision is available. So, if the market has one or more rational players, the market should converge to a price of 0 or 1 immediately, depending on the state of the problem. Right?<\/p>\n<\/blockquote>\n

He then offers a few choices when the market, presumably, does not give such a result:<\/p>\n