The dumb agent theory (DAT) 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 The efficient-market hypothesis (EMH) is a hypothesis in financial economics that states that asset prices reflect all available information. A direct implication is that it is impossible to "beat the market" consistently on a risk-adjusted bas ...

(EMH). One of the first instances of the dumb agent theory in action was with the

Policy Analysis Market The Policy Analysis Market (PAM), part of the FutureMAP project, was a proposed futures exchange developed, beginning in May 2001, by the Information Awareness Office (IAO) of the United States Defense Advanced Research Projects Agency (DARPA), a ...

(PAM); a futures exchange developed by

DARPA The Defense Advanced Research Projects Agency (DARPA) is a research and development agency of the United States Department of Defense responsible for the development of emerging technologies for use by the military. Originally known as the Adv ...

. While this project was quickly abandoned by

the Pentagon The Pentagon is the headquarters building of the United States Department of Defense. It was constructed on an accelerated schedule during World War II. As a symbol of the U.S. military, the phrase ''The Pentagon'' is often used as a metony ...

, its idea is now implemented in

futures exchanges A futures exchange or futures market is a central financial exchange where people can trade standardized futures contracts defined by the exchange. Futures contracts are derivatives contracts to buy or sell specific quantities of a commodity or fi ...

and

prediction markets Prediction markets (also known as betting markets, information markets, decision markets, idea futures or event derivatives) are open markets where specific outcomes can be predicted using financial incentives. Essentially, they are exchange-trad ...

such as

Intrade Intrade.com was a web-based trading exchange whose members "traded" contracts between each other on the probabilities of various events occurring. After having been forced to exclude US traders in 2012, on 10 March 2013 Intrade suspended all tra ...

Newsfutures Prediction markets company NewsFutures (2000-2010) has evolved into Lumenogic, "a consulting firm that specializes in developing and customizing online systems for large organizations to use to gather so-called Collective Intelligence from their ...

and Predictify. The DAT is technically a

hypothesis A hypothesis (plural hypotheses) is a proposed explanation for a phenomenon. For a hypothesis to be a scientific hypothesis, the scientific method requires that one can test it. Scientists generally base scientific hypotheses on previous obse ...

, not a

theory A theory is a rational type of abstract thinking about a phenomenon, or the results of such thinking. The process of contemplative and rational thinking is often associated with such processes as observational study or research. Theories may be s ...

. 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 Michael Surowiecki ( ; born April 30, 1967) is an American journalist. He was a staff writer at ''The New Yorker'', where he wrote a regular column on business and finance called "The Financial Page". Background Surowiecki was born in Meri ...

in 1999.The Dumb Smart Market – James Surowiecki – Slate Magazine
/ref> 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 is a psychological phenomenon that occurs within a group of people in which the desire for harmony or conformity in the group results in an irrational or dysfunctional decision-making outcome. Cohesiveness, or the desire for cohesiveness ...

, the

bandwagon effect The bandwagon effect is the tendency for people to adopt certain behaviors, styles, or attitudes simply because others are doing so. More specifically, it is a cognitive bias by which public opinion or behaviours can alter due to particular acti ...

and the

Abilene paradox In the Abilene paradox, a group of people collectively decide on a course of action that is counter to the preferences of many or all of the individuals in the group. It involves a common breakdown of group communication in which each member mistak ...

PAM

The

(PAM), while technically a futures market, was described as utilizing the dumb agent theory.">CCC - DARPA’s Policy Analysis Market (The "Terrorism Market")
/ref> The main difference, as argued by

, 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) was a ''Skipjack''-class nuclear-powered submarine that served in the United States Navy, and the sixth vessel, and second submarine, of the U.S. Navy to carry that name. ''Scorpion'' was lost with all hands on 22 ...

was a nuclear submarine of the

United States Navy The United States Navy (USN) is the maritime service branch of the United States Armed Forces and one of the eight uniformed services of the United States. It is the largest and most powerful navy in the world, with the estimated tonnage ...

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 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 USS Scorpion (SSN-589), USS ''Scorpion'', and has played a key role in the recover ...

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.

References

{{reflist

External links

*
Dumb Agent Theory Explained
at ''DumbAgent.com'' Behavioral finance Theory of value (economics)