An Alteration of Asimov’s Parable: The Paradox of the Efficient Market Theorem & Quantum Economics

“God does play dice”

Let me begin with a slight alteration to Asimov’s parable from Robots in Time –

A scientist travels two centuries into the future and is shown a civilization where mankind has succumb to the decadence of robots. When he returns and reports this, one of the persons who hears his account is a prototype human-looking robot. The robot then buries a note for the robots of the future to discover so that they can convince the time traveller that humanity will triumph.

The prior is an illustration of a paradox – the robot’s actions nullifies the original prediction; however, if the original prediction is nullified then the original prediction could have never taken place, and the robot could never have taken advantage of it; this in turn, nullifies the robot’s actions which allows the original prediction to take place, etc etc.

This is not only a problems posed by time travel, but it also illustrates a problem with any theory where a deterministic outcome is itself a variable for its own outcome. This is very much true in classical, neoclassical economics, and the efficient market theories – as I like to call them “deterministic economics” – where there is one expected outcome through the amalgamation of rational decisions. Markets are always optimal in the long run, where the price of the commodity reflects its true economic values -as Hayek referred to the markets as “telecommunication systems”, which disperses information via prices. However if decisions are truly made rationally, then they would have to take into account the prospects of the future; the expectations of the markets are thus a variable of rational economic decision making; this is especially true for investors and stockbrokers. Now, as exemplified in our version of Asimov’s parable, we have a paradox. If the models make a prediction, then the rational decision makers will now change their behaviors to take advantage of the prediction, nullifying the original prediction. Now if we predicted that the original prediction would be nullified, then that would nullify the original motive for rational decisions to change behaviors, etc etc.

Economics thus cannot be deterministic at least to be consistent with itself. Deterministic economics isn’t that far-fetched however. If we believe in rational decision making, then we would expect certain outcomes in both micro and macro – that which benefits the individual the most. This is exemplified by indifference curves on the micro-level and by market equilibriums at the macro level. And there is plenty of evidence to believe that both society and nature work in a rather rational manner.

However, countering this train of thought and an attempt to explain why, is the idea of how the rational decisions of individuals may inevitably manifest in unpredictable and irrational decision making. Decisions are interdependent; at least in well developed markets, no longer is only the utility of a product important (the useful-ness of the product to the buyer) but also is the perceived utility for others (the useful-ness of the product perceived by other buyers). This is especially true in the financial market but is also true for commodities, which are used as financial instruments. A stockbroker will not purchase stock that he himself thinks is valuable; the stockbroker will buy equities that he thinks others think is valuable. If all stockbrokers are thinking along these lines then they will buy the equities, which he thinks others will buy – equities that they think that others will think are valuable! The competition between rational players undercuts rational decisions until it manifests itself in seemingly unintuitive results. The markets thus will not act uniformly and predictably because there are constant outliers attempting to take advantage of the outcomes of the market. If the markets are indeed efficient as stated by the efficient market theory, then the individuals who try to capitalize on the efficiencies of the market inevitably make it inefficient.

It is important however to note that this may not apply or apply to the same degree for primitive markets, where the consumers are only concerned with consuming rather than investing; where the prospects of the market are not a variable (or not as much) in decision making. Perhaps these markets are efficient and works as Hayek depicted them, however the markets of today are surely much more developed.

How do we reconcile this fact in to our economic models, where a number of variables are simply inserted to get one correct answer? Perhaps the markets are not as efficient as we would like them to be. Perhaps Minskys’ theories on inherent market instability is more reflective of the truth. Perhaps our expectation for one answer is wrongly placed; perhaps there is no determined future to predict. As the ole’ quote from quantum physics goes “god does play dice”. Maybe like quantum mechanics, we should be attempting to find the probabilities of outcomes instead – call it “quantum economics”. Although this may also be affected by those outliers who work against such predictions, it would be much closer in reflecting reality – something our models need more of.

“God does play dice.”

Kai Matsuda

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