We write about the Common Knowledge Game a lot in Epsilon Theory, because it’s the central game of crowds and narratives.
Common knowledge is something that we all believe everyone else believes.
We don’t have to believe it ourselves, and it doesn’t even have to be public knowledge. But whether or not you personally believe something to be true, if you believe that everyone else believes something to be true, then the rational behavior is for you to act AS IF you believe it, too. Or at least that’s the rational behavior if you want to make money.
Common knowledge is rarer than you think, at least for most investment theses. That is, there’s almost always a bear case and a bull case for a stock or a sector or a geography, and god knows there are plenty of forums for bulls and bears to argue their respective cases.
What can change this normal state of affairs … what can create common knowledge out of competing opinions … are the words of a Missionary. In game theory terms, the Missionary is someone who can speak to everyone AND who everyone takes seriously. Or at least each of us believes that everyone else hears the Missionary’s words and takes them seriously.
When a Missionary takes sides in a bull vs. bear argument, then depending on the unexpectedness of the words and the prestige of the Missionary, more or less powerful common knowledge is created. Sometimes the original Missionary’s words are talked down by a competing Missionary, and the common knowledge is dissipated. Often, however, the original Missionary’s words are repeated by other, lesser Missionaries, and the common knowledge is amplified.
When powerful common knowledge is created in favor of either the bull or bear story, then the other side’s story is broken. And broken stories take a looooong time to heal, if they ever do. Again, it’s not that the bulls or the bears on the wrong side of the common knowledge are convinced that they were wrong. It’s not that the bulls or the bears on the wrong side of the common knowledge necessarily believe the Missionary’s statements. But the bulls or the bears on the wrong side of the common knowledge believe that everyone ELSE believes the Missionary’s statements, including everyone who used to be on their side. And so the bulls or the bears on the wrong side of the common knowledge get out of their position. They sell if they’re long. They cover if they’re short.
Last Friday the SEC – a very high prestige Missionary due to their neutrality and sheer regulatory muscle – created VERY powerful common knowledge on Tesla. It wasn’t just that the SEC said they were investigating Elon Musk and the Board for the whole “funding secured” fiasco. No, what was unexpected – and thus extremely powerful from an information theory perspective – was that the SEC said they had been investigating Elon Musk and the Board for quite some time now, thank you very much, over more serious and widespread issues than “funding secured”. Boom!
And just like that the bull story on Tesla was broken. If you were long Tesla, you felt like you HAD to sell, whether or not it changed your personal beliefs or views about the stock.
IT’S THE RATIONAL THING TO DO.
To read more about the Common Knowledge Game …
- Harvey Weinstein and the Common Knowledge Game
- Sheep Logic
- When Does the Story Break
- A Game of Sentiment