Profiting illicitly from chance

2009-01-30

in Economics, Security

Canada's eternal flame, Parliament Hill

Skimming through a local newspaper the other day, I came across an advertisement for ‘investment advice.’ Basically, it was someone hoping to manipulate random chance to make a profit. It worked like this:

  • You sign up and, for the next month, you get free weekly investment advice.
  • You are encouraged to either invest according to the advice or pretend that you have done so, keeping track of the relevant stocks and how much you would have earned if you had invested.
  • After the free trial period, you start paying a fee for further advice.

The system works in a pretty obvious way. The people running it either produce one weekly piece of advice or, if they are smarter, many. They then send this information to people at random. Naturally, some of the advice will lead to real or simulated losses. Those people will stop taking the advice. Some people, however, will receive seemingly good advice week after week. These people, impressed with the ‘track record’ of the financial advisors will presumably start paying for the information, perhaps giving up when things inevitably go wrong.

You could perform the same trick with any random and money-connected activity: betting on races or sporting events, commodity prices, and so forth. In every case, enough random sets of advice being distributed will lead to a subset of people winning on the basis of the ‘advice’ several times in a row.

At one level, this is a pretty simple confidence trick. At the same time, it isn’t hugely different from what a lot of legitimate financial firms do from day to day. Buying mutual funds, in particular, bears similarities. People evaluate funds based on their past performance, despite how that may have been the product of chance rather than good choices. At least some mutual funds will always do well, driving people to believe that money can be made with them. In fact, mutual funds are more insidious than the con described above. That is because they charge management fees. As a result, there are likely to be many circumstances in which fund managers are getting paid on a day-to-day basis for making trades that underperform the market.

Incidentally, a related trick could be performed with fake medicine: offer it to sick people for free, to begin with, then start selling it to the ones who happen to see their condition improve significantly for unrelated reasons during the ‘treatment’ period. This would work especially well with chronic conditions where the level of suffering varies significantly from one point in time to the next.

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{ 3 comments… read them below or add one }

R.K. January 30, 2009 at 10:30 am

With the right disclaimer, the ‘investment advice’ and ‘sports betting’ scams may not even be illegal.

Milan January 30, 2009 at 11:40 am

Something along the lines of “for entertainment purposes only?”

. February 6, 2009 at 10:41 am

In defense of economists

By Economist.com | NEW YORK

MY COLLEAGUES have expressed their frustration at the economics profession. Some economists share their despair at the way the field has failed throughout this crisis. It’s strange; I find it an exhilarating time to be an economist. Rather than seeing everything I learned turned on its head, I see many theories proven each day, and gain an even deeper understanding of them.

The disappointment many non-economists feel is probably the result of unrealistic expectations. Contrary to the prevailing view, no economist I know of has, or ever had, a perfect understanding of the economy. Some understand it better than others, but the nature of research is the eternal struggle to figure out what exactly is happening.

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