# Thread: Paper: "Optimal Disclosure Policy and Undue Diligence"

1. ## Paper: "Optimal Disclosure Policy and Undue Diligence"

A recent paper published by the St Louis Fed discusses information access as a feature that is best limited in certain cases.

My understanding of the paper is that the author thinks socially desirable outcomes are advanced by the limiting of access to certain information. This is supposedly supported by Hirshleifer (1971), who I have not read.

The authors posit situations where, basically, keeping real expectations or perceived risk out of the public eye promotes a better societal outcome. Sound to me like insiders don't want open markets, they want to stay insiders by not disclosing info to the general public.

I don't quite get the argument... I guess they may be talking about public confidence being crushed by world events behind the scenes, e.g. anticipated currency crash, real danger of nuclear power plants, terrorist plots, etc.

Excerpts from the article:

"Nondisclosure is complicated, however, by the fact that individuals may
discover hidden information on their own. Formally, we assume that individu-
als possess an information acquisition technology, similar to the “costly-state-
verification” technology modeled in Townsend (1979). That is, individuals may,
at some cost, surreptitiously discover on their own, what society wishes to re-
main hidden. We refer to this action as “undue diligence,” because the activity,
as we model it here, is harmful from the perspective of our social welfare crite-
rion"
.

Who are the "individuals" and what "society" wishes info hidden?

"Information that forecasts future asset returns is potentially available at zero cost; and society must choose
whether to make this information available for public viewing or not. In the
set-up considered here, it is generally desirable to suppress this particular infor-
We refer to this action as “undue diligence,” because the activity,
as we model it here, is harmful from the perspective of our social welfare crite-
rion.
mation flow (or to disclose it with delay). [ ... ] and society must choose
whether to make this information available for public viewing or not. In the"Nondisclosure is complicated, however, by the fact that individuals may
discover hidden information on their own. Formally, we assume that individu-
als possess an information acquisition technology, similar to the “costly-state-
verification” technology modeled in Townsend (1979). That is, individuals may,
at some cost, surreptitiously discover on their own, what society wishes to re-
main hidden.
set-up considered here, it is generally desirable to suppress this particular information"

Sounds as if "future asset returns" are only to be estimated and published for some select few?

"In such a circumstance, individuals may collectively
choose to design (or support) institutions that suppress the publication of so-
cially harmful information. "

The concept of "undue dilligence" seems like the creation of a fevered mind, and what is "socially harmful information"?

Can anyone explain how lack of transparency is good for markets?

2. I haven't read the paper and don't know about the argument, but surely one can come up with instances of 'too much information'. A relatively benign example is that usually one would prefer not to see how food is made in a restaraunt (depends on the restaraunt and chef's cleanliness).

I haven't read the paper and don't know about the argument, but surely one can come up with instances of 'too much information'. A relatively benign example is that usually one would prefer not to see how food is made in a restaraunt (depends on the restaraunt and chef's cleanliness).
The line between self-deception and delusion can be a thin one. When looking at financial decisions, does it make sense to avoid information that would be controversial or shocking?

There's some elitist attitude here in which the authors have decided that maximizing their 'social welfare criterion' involves keeping some people ignorant of reality. This seems controversial to me, yet is written as if no one could possibly object.

4. Originally Posted by robdashu
Can anyone explain how lack of transparency is good for markets?
Hello, and thank you for your interest in our paper (I am one of the authors, D. Andolfatto).

As we remark in our paper, the idea that less information can be better than more in financial markets is counterintuitive. Nevertheless, economists have known about this for a long time. Let me try to describe one example provided in the original Hirsleifer paper.

Scenario: You live on an island with 99 other people. You all know that one of you has an incurable disease that will render the afflicted person crippled for life in one year's time. What nobody knows is the identity of the person so afflicted.

In this scenario, it would be natural for people to enter into some sort of insurance arrangement. Everybody deposits their insurance premiums in a fund. In one year's time, the afflicted person gets to collect the insurance money, which will help him/her cope with their disability. Everybody is made better of *ex ante* (before the fact) if they enter into this insurance arrangement. That is, social welfare is maximized in this case.

But now, just before everyone signs the insurance contract, imagine that a doctor bursts into the room and announces "Hold on! I have a new technology that can costlessly reveal who has this horrible disease!"

The question put forth by Hirshleifer is: Would these people want the doctor to make this information public?

The answer, according to Hirshleifer is: No. Making the information public would destroy the insurance market. (The people without the disease would never pay premiums.) Of course, *ex post* (after the fact), those that do not have the disease are better off, and the unlucky person who has the disease is made worse off. From an ex ante perspective, information disclosure reduces social welfare in this example.

5. The problem I have with this concept is that, ex ante, those not 'in the know' cannot make fully-informed decisions, and those 'in the know' postulate what the effects will be of this withholding of information.

I can see scenarios in which the concept can apply, like the one you sited with the insurance market, but there is some difficulty showing that total utility is maximized. There is a side-issue of the cost to the many of the insurance that benefits the one. What level of contribution is 'just' or 'socially optimal'? Secondly, the insurance marketers make significant return from the withholding of the info.

It is, seriously, a case of elites with information trying to justify 'protecting' the man in the streets from reality. This superior attitude justifying that the info should be withheld is the stumbling block for me. Some outcomes may seem to worsened, e.g. The sick person doesn't get any benefits, but the ultimate outcome is based on some individual's judgement of the situation, ex ante, i.e. playing god.

6. The subject is somewhat charged in this day of centrally-sourced information. Controlling/ censoring info flow to the public is a slippery slope. Clearly, it reflects a 'big brother', controlling central perceptions and able to selectively inform the populace in areas where they deem it optimal.

So, it's the uses to which this insight may be applied that trouble me if the concept is institutionalized. It seems like a rationale for practicing mis-or dis-information policies.

Thank you, by the way, for visiting and discussing your paper with us.

7. I should mention that transparency and information imbalances seem to be a major problem with free markets. In limited cases, I can accept that worse outcomes would be attained by distributing certain information broadly. The fact that one must reach to insurance markets to find an example is not exceptionally reassuring; in my mind, the insurance industry is a bit of a racket, though conceptually sound.

So my guiding principle is that more transparency is always better. I may not be a good person to try to convince, due to my skepticism.

8. Rob, thank you for bringing a guest speaker to the forum. *That is awesome.

The paper is, like all of it's kind, necessarily and unfortunately a very difficult read. *My experience, having written similar papers, is that they are perfectly clear to the author and then, as your familiarity with the subject matter and mathematics declines, clarity diminishes exponentially. *I often wish that the summary would be written in a progression of audiences, starting from a general audience level and progressing upward. *

It will take me some considerable effort if I'm to be able to fully grasp the core of the article.

Never the less, it did suggest to me some ideas.

The first and overriding consideration for any particular individuals opinion is how they rank personal cost against social cost. *The guest speakers example is quite adequate to this regard. *

The first issue is how you value the life of another pesrson. *If there are 100 people, all in perfect health, and one dies that isn't you, then there is a social cost as society is now lessened by one. *Individually, you may even see their demise as a benefit, after all, competition has been lessened by one.

**If, in fact, you consider your personal welfare equally on par and comingled with overall welfare, the issue becomes more complex. *Even if you don't, the fact that individual cooperation increases production efficiency, you may still see the utility in *considering social cost.

In terms of assets and information, a difference in perspective depends on if you believe you are the person that is going to know the info first and beat everyone else out by having the info first.

I think, though, that the authors point is in more general terms to measuring overall economic health and efficiency. *Often, as we are well aware, a herd mentality sets in. *Lacking long run commitment to the asset, when information suggests that the asset will fail to perform as expected, sufficient asset owners jump ship. This causes a sudden drop in short term prices which triggers further sales. The whole investment program collapses and, as we saw with the housing and mortgage industry, it takes the entire system down with it. *

And the idea doesn't necessarily require a bubble. *Economic and business processez are highly volitile on a day to day cycle. Business sale should follow a poisson distribution, as a quick guess. *On any particular day they may be zero. *So what if investors were aware of that day to day information? *Lacking long term commitment to the investment, they sell their interest. *This cause a fall in the investment value triggerig further investment to pull out.

That is my best take on it, at least until I can get through the math.

9. Your right about the insurance industry being a racket but that is because it is often not really selling a true insurance product.

One example, and this isn't the insurance companies fault, is dental coverage. If you have insurance, a crown costs $1000 with the dental coverage picking up 50%. If you don't have coverage, the dentist will do the work for half off, only$500. Of course, your out of pocket expenses are still \$500.

What was really going on was that the dentist made more from people with insurance. And the out of pocket cost also included the premiums.

10. The reason it bothers me is that, to me, that is one of the most important prerequisites of a free market, is the level information playing field. I know it is only an ideal, but it's one to strive for, IMO. For instance, if there were some catastrophic event looming that only top scientists and politicians knew about, they would justify withholding the information because of the panic and chaos it would cause. Is that ethical or moral?

In case of a looming financial catastrophe, those with knowledge stand to benefit from huges transfers of wealth. In the case of market economics, there is a grey area between proprietary methods and the public's right to know of costs foisted off on the general public, either environmentally, health wise, or through fraud.

Sitting on information requires extremely strong justification, otherwise, the withholder is playing god to one degree or another, intentionally misshaping someone else's reality. Is that a definition of propaganda?

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