What you don’t know that you don’t know

Bryan Caplan writes:

A common Austrian slogan is that "Neoclassical economists study only cases where people know that they don’t know; we study cases where people don’t know that they don’t know."

He demands a good example in support of the Austrian view.  I would cite the arrival of the Spaniards during the time of the Aztecs and the subsequent conquest (see also Fabio’s comment on Bryan’s post).  This was not literally an unimaginable event, since it had (in modified form) been foretold by Nahua prophecy, but still the Aztecs had no ability to respond effectively, given their prevailing mental frameworks. 

More generally, look at the implied volatility embedded in options prices.  Is it forecasting how much volatility is really out there?  Here’s one possible quantitative measure: if you have futures on options, take the measure of "surprise" in implied volatility (the change in implied volatility not forecast by the futures price for the options contract) as the relevant measure of "what you didn’t know that you didn’t know."  I’m not saying this figure is large, or even necessarily positive on average, but I do think it is a meaningful concept.  Arnold Kling responds to Bryan as well.  Here is my previous post on this topic.


The request was not for events anticipated but not in much detail - that is most every event. The request was for events for which people didn't even have a category to describe them.

For fully unanticipated, there is the impact of disease on the Aztecs and other native americans. Nobody on either side anticipated the devastation that would result when the Spaniards and others brought over European diseases. A 75% population loss was beyond their expectation, and vastly exceeded to worst prior experiences with famine and war.

"The request was not for events anticipated but not in much detail - that is most every event. The request was for events for which people didn't even have a category to describe them."

You mean like the (heretofore unknown) 5th horseman of the apocalypse?

That sort of thing?

I don't think that Robin identifies the problem correctly. Ex post there is always a category you can put an event under, if only the general category of "unexpected event." The relevant question is whether fuzziness of categories leads to systematic mistakes. Maybe it does or doesn't but I think that way of posing the problem makes perfect sense and it is not the kind of meaningless nonsense that Bryan wants to attribute to the Austrian theory. That said, the Austrian theory can be charged with insufficient clarity on what the concept of radical uncertainty means.

Other than the timing of events, there is nothing that comes to mind that has outright surprised me. That includes 9/11, the flooding of New Orleans, or any of the recent bursting bubbles (dotcom, real estate, and soon-to-be commodoties).

I'd add the decline of a certain empire, which I know won't be a popular sentiment in this particular blog.

I've been following this discussion this morning, and in my own research came across a simple example that I haven't seen mentioned here yet. A young child does not know that she does not know calculus -- an unknown unknown.

Stock picking vs investing in an ETF. Stock pickers don't know that they don't know, otherwise they would pick the ETF every time.

"we study cases where people don't know that they don't know."

How pure do we have to be in our "unknown unknowns"? September 11 2001 was eminently predictable - I was shocked, but not surprised - and Taleb's famous example, the black swan, was hardly even surprising, if thought about rationally. Quantifiable versus unquantifiable, or insurable versus uninsurable, would be a far more useful distinction, and is where the Austrians can usefully critique the neoclassicals.

Most ideas of unknown unknowns focus on the negatives - war, famine, plague, terror, which are all significantly frequent not to count - yet the most obvious and significant example is positive. Until approx. 1800, world GDP had never grown by more than a fraction of a percent per year. That GDP per capita would then grow at 1.5% for 200 years, while population grew at over 1%, would have seemed exceptionally unlikely, far more so than any amount of war etc. Go back a further 300 years, to when European GDP per capita had been static for 1000 years, and the idea of such profound long term growth would probably have seemed impossible. If there had been any economists around in 1500, I guess they would have been convinced of the impossibility of all but the slightest long term growth; after all, conditions might fluctuate, but everyone knew that while populations might grow slightly, people never got any richer, on average - and they would have had several thousand years of statistics* to prove it. They could easily have statistically "proven" the negative serial correlation of income per capita, over most all of recorded history.

*Assuming, counterfactually, that they had such statistics and the ability to interpret them.

Couldn't you just look at the implied vol on an option on an option?

λ=h/p → P=h/λ (The story of de Broglie hypothesis)
plus my experience of learning this hypothesis

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