Information economics is philosophical in the sense of the roots of the word philosophical (phil = liking & soph = complexity). Information economics can help us understand one of the complexities of the world -- how the non-zero cost of information affects the actions of producers and consumers. I would argue that it applies to financial markets in interesting ways. For example isn't declaring a dividend an example of signalling and isn't a conglomerate an example of bundling? Nor would I say that information economics can't be discerned in the data. Doesn't the fact that many investors under-diversify suggest some sort of cost-of-information effects? Isn't it clear that CAPM doesn't explain the data very well and that we either need to reject CAPM or find those add-ons that make CAPM more realistic?I suspect that two issues are the root of the problem. First, the proponents of CAPM would assert that information costs are negligible or are somehow averaged out or premiumed-out of the equation. At first glance, they may be correct because so many people can so easily find so much free information on the internet. At another level, they are terribly wrong because the true cost of information is dominated by interpretation labor, not access costs. CAPM assumes that the invisible hand has an all-seeing eye. Information economics recognizes that each participant's eye takes time and effort to observe the data before dipping their hand in the market.Second, one of the sad facts of academic economics is that so much of it is constrained by a decades-old edict to use analytic math. As wonderful as math is, it often requires ludicrous assumptions to ensure tractability. Analytic math is like a telescope in that it is great for zooming in on the logical structure of the universe but it is only useful in very limited set of circumstances (clear nights, distant objects, etc.).Perhaps there's a deep irony here in that the bounded capabilities of our smartest mathematicians require us to assume unbounded capabilities of our dumbest investors.
Last edited by Traden4Alpha
on April 16th, 2007, 10:00 pm, edited 1 time in total.