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Richard Zeckhauser: Investing in the Unknown and the Unknowable

September 11, 2012

It is pretty rare that I enjoy reading an academic paper on investment decisions, but I really enjoyed this one by Richard Zeckhauser. In particular, I can’t think of any other papers that are so clear about how one should think about investing it situations where there are large unknowns mixed with potentially asymmetric information on each side. His conclusions are summarized into 9 maxims and I think all of his reasonings and examples are well thought out. It also doesn’t hurt that he is clearly aware of the lines of thinking Buffett and Munger use when making their investment decisions in light of uncertainty.

Maxim I: Do not engage in heuristic reasoning that just because you do not know the risk, others do. Think carefully, and assess whether they are

likely to know more than you. When the odds are extremely favorable, some­
times it pays to gamble on the unknown, even though there is some chance
that people on the other side may know more than you.

http://www.hks.harvard.edu/fs/rzeckhau/unknown_unknowable_PUP.pdf

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