Dumb agent theory
Encyclopedia
The dumb agent theory states that many people making individual buying and selling decisions will better reflect true value than any one individual can. In finance this theory is predicated on the efficient-market hypothesis (EMH). One of the first instances of the dumb agent theory in action was with the Policy Analysis Market
(PAM); a futures exchange developed by DARPA. While this project was quickly abandoned by the Pentagon
, its idea is now implemented in futures exchanges and prediction markets such as Intrade
, Newsfutures
and Predictify
. The DAT is technically a hypothesis
, not a theory
.
While first mentioned strictly by name in relation to PAM in 2003, the dumb agent theory was originally conceived (as the Dumb Smart Market) by James Surowiecki
in 1999. Here, Surowiecki differentiated from the EMH stating that it "doesn't mean that markets are always right." Instead, he argues that markets are subject to manias and panics because "people are always shouting out" their stock picks. This, in turn, results in other investors worrying about these picks and becoming influenced by them, which ultimately drives the markets (irrationally) up or down. His argument states that if market decisions were made independently of each other, and with the sole goal of being correct (as opposed to being in line with what others are choosing), then the markets would produce the best choice possible and eliminate biases such as groupthink
, the bandwagon effect
and the Abilene paradox
.
(PAM), while technically a futures market, was described as utilizing the dumb agent theory. The main difference, as argued by James Surowiecki
, is that in a futures market the current stock prices are known in advance, while in order for the dumb agent theory to work, they should be unknown to the investor prior to the decision making period (which is possible only with a prediction market).
was a nuclear submarine of the United States Navy
lost at sea on June 5, 1968. While a public search did not yield any clues as to its location, Dr. John Craven, the Chief Scientist of the U.S. Navy's Special Projects Division, decided to employ the Bayesian search theory
in order to establish its location. This involved formulating different hypotheses as to its location and using a probability distribution to combine the information and find the point of highest probability. The different hypotheses were taken from various independent sources, such as mathematicians, submarine specialists, and salvage men. The point Craven found ended up being 220 yards from the actual position of the sunken vessel.
Policy Analysis Market
The Policy Analysis Market , part of the FutureMAP project, was a proposed futures exchange developed by the United States' Defense Advanced Research Projects Agency and based on an idea first proposed by Net Exchange, a San Diego research firm specializing in the development of online prediction...
(PAM); a futures exchange developed by DARPA. While this project was quickly abandoned by the Pentagon
The Pentagon
The Pentagon is the headquarters of the United States Department of Defense, located in Arlington County, Virginia. As a symbol of the U.S. military, "the Pentagon" is often used metonymically to refer to the Department of Defense rather than the building itself.Designed by the American architect...
, its idea is now implemented in futures exchanges and prediction markets such as Intrade
Intrade
Intrade is an online trading exchange website. The website's members speculate on the outcomes of non-sports-related future events. Intrade was founded by John Delaney in 2001 and acquired by Tradesports in 2003. Dublin-based owner Trade Exchange Network Limited also operated TradeBetX.com, which...
, Newsfutures
NewsFutures
Prediction markets company NewsFutures has evolved into , "a consulting firm that specializes in developing and customizing online systems for large organizations to use to gather so-called Collective Intelligence from their employees."...
and Predictify
Predictify
Predictify.com was a Web 2.0 company based in Redwood City, California. It was founded by Stanford University graduates Parker Barrile and Michael Agnich. It went out of business in 2009, . A similar "news prediction site" called HubDub also has closed...
. The DAT is technically a hypothesis
Hypothesis
A hypothesis is a proposed explanation for a phenomenon. The term derives from the Greek, ὑποτιθέναι – hypotithenai meaning "to put under" or "to suppose". For a hypothesis to be put forward as a scientific hypothesis, the scientific method requires that one can test it...
, not a theory
Theory
The English word theory was derived from a technical term in Ancient Greek philosophy. The word theoria, , meant "a looking at, viewing, beholding", and referring to contemplation or speculation, as opposed to action...
.
While first mentioned strictly by name in relation to PAM in 2003, the dumb agent theory was originally conceived (as the Dumb Smart Market) by James Surowiecki
James Surowiecki
James Michael Surowiecki is an American journalist. He is a staff writer at The New Yorker, where he writes a regular column on business and finance called "The Financial Page".-Background:...
in 1999. Here, Surowiecki differentiated from the EMH stating that it "doesn't mean that markets are always right." Instead, he argues that markets are subject to manias and panics because "people are always shouting out" their stock picks. This, in turn, results in other investors worrying about these picks and becoming influenced by them, which ultimately drives the markets (irrationally) up or down. His argument states that if market decisions were made independently of each other, and with the sole goal of being correct (as opposed to being in line with what others are choosing), then the markets would produce the best choice possible and eliminate biases such as groupthink
Groupthink
Groupthink is a psychological phenomenon that occurs within groups of people. It is the mode of thinking that happens when the desire for harmony in a decision-making group overrides a realistic appraisal of alternatives. Group members try to minimize conflict and reach a consensus decision without...
, the bandwagon effect
Bandwagon effect
The bandwagon effect is a well documented form of groupthink in behavioral science and has many applications. The general rule is that conduct or beliefs spread among people, as fads and trends clearly do, with "the probability of any individual adopting it increasing with the proportion who have...
and the Abilene paradox
Abilene paradox
The Abilene paradox is a paradox in which a group of people collectively decide on a course of action that is counter to the preferences of any of the individuals in the group. It involves a common breakdown of group communication in which each member mistakenly believes that their own preferences...
.
PAM
The Policy Analysis MarketPolicy Analysis Market
The Policy Analysis Market , part of the FutureMAP project, was a proposed futures exchange developed by the United States' Defense Advanced Research Projects Agency and based on an idea first proposed by Net Exchange, a San Diego research firm specializing in the development of online prediction...
(PAM), while technically a futures market, was described as utilizing the dumb agent theory. The main difference, as argued by James Surowiecki
James Surowiecki
James Michael Surowiecki is an American journalist. He is a staff writer at The New Yorker, where he writes a regular column on business and finance called "The Financial Page".-Background:...
, is that in a futures market the current stock prices are known in advance, while in order for the dumb agent theory to work, they should be unknown to the investor prior to the decision making period (which is possible only with a prediction market).
Prediction markets
For the dumb agent theory to hold, investors should not know what other investors are doing prior to making their decision. While this is technically impossible in a futures exchange (because what other people are deciding dictates the price of the security), it can be done in a Prediction Market. Certain prediction markets are set up in this manner (Such as Predictify, although it allows for participants to change their answers after their initial prediction).Dumb agent theory outside the financial markets
USS Scorpion (SSN-589)USS Scorpion (SSN-589)
USS Scorpion was a Skipjack-class nuclear submarine of the United States Navy, and the sixth ship of the U.S. Navy to carry that name. Scorpion was declared lost on 5 June 1968 with 99 crew members dying in the incident. The USS Scorpion is one of two nuclear submarines the U.S...
was a nuclear submarine of the United States Navy
United States Navy
The United States Navy is the naval warfare service branch of the United States Armed Forces and one of the seven uniformed services of the United States. The U.S. Navy is the largest in the world; its battle fleet tonnage is greater than that of the next 13 largest navies combined. The U.S...
lost at sea on June 5, 1968. While a public search did not yield any clues as to its location, Dr. John Craven, the Chief Scientist of the U.S. Navy's Special Projects Division, decided to employ the Bayesian search theory
Bayesian search theory
Bayesian search theory is the application of Bayesian statistics to the search for lost objects. It has been used several times to find lost sea vessels, for example the USS Scorpion.-Procedure:The usual procedure is as follows:...
in order to establish its location. This involved formulating different hypotheses as to its location and using a probability distribution to combine the information and find the point of highest probability. The different hypotheses were taken from various independent sources, such as mathematicians, submarine specialists, and salvage men. The point Craven found ended up being 220 yards from the actual position of the sunken vessel.
External links
- "Dumb Agent Theory Explained" at DumbAgent.com