If we needed a reminder of the power of information, the indictment of SAC Capital Advisors by a grand jury for insider trading was that cue.
The court papers (available at http://goo.gl/HsmhAF) make clear how valuable an information advantage can be in market settings.
Of course, the practices outlined in the indictment are illegal. However, there are many other market interactions in which an information advantage is legal and equally valuable.
Economists have long studied information markets. One textbook example that we all encounter is the “market for lemons.” Sellers of used cars often have more information about their true quality than buyers.
This can — in the extreme — lead to a complete breakdown in trading: Exchanges between buyers and sellers do not happen even though they would be valuable because of the lack of trust.
One way to address such market failures is through government regulations. Many laws in place make it easier for buyers to hold unscrupulous sellers accountable.
However, as private market solutions like Carfax.com have shown, free enterprises can be innovative when it comes to safeguarding the existence of profitable markets. Trust can be built through market solutions that alleviate what economists have termed “asymmetric information” scenarios.
Another great example of how legal “insider” information benefits those “in the know” is research into home purchases when real estate salespeople are looking to buy or sell houses for themselves.
There is a long-running (less than friendly) exchange between the authors of “Freakonomics” and the National Association of Realtors due to the economists suggesting “Realtors are incented to use proprietary information to the disadvantage of their customers.”
They cite research stating that properties on sale by realtors for their own account are on average on the market for 10 days longer than when they sell for others.
Of course, Dubner and Levitt also state: “Don’t be so smug: You probably would too if you were a Realtor” (http://goo.gl/QXW65t).
Earlier this year, economists published yet another such legal “insider” analysis.
In “Physicians treating physicians: Information and incentives in childbirth,” Erin Johnson (MIT) and M. Marit Rehavi (British Columbia), “compare the treatment of physicians when they are patients with that of comparable non-physicians” (available at: http://goo.gl/hrtaYg).
They find that “physicians are almost 10 percent less likely to receive a C-section” and that “physicians also have better health outcomes, suggesting overuse of C-sections adversely impacts patients health.”
There is, of course, nothing wrong with such better informed “physician patients” or “realtor-sellers” making superior decisions.
What this type of research teaches us, however, is that we should be in favor of, first, market solutions that make information more widely available and, if that fails, some limited regulation with the same goal.
One obvious candidate for such solutions are high-frequency trading practices (currently being probed by the Financial Industry Regulatory Authority). In this case, huge trades are made in fractions of a second to make profits of millions of small trades. That puts “normal” traders at a disadvantage — and it is not clear whether it adds to the efficiency of markets.
Of course, the health-care example above also shows that we are probably correct when we feel disadvantaged while navigating the Babylonian labyrinth of health care insurance here in the U.S.
Sometimes, not having the right information makes one sick to the stomach.
Dr. Michael Reksulak has taught economics and public finance in Georgia Southern University’s College of Business Administration. He can be contacted at MReksulak.SMN@gmail.com.