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.


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