The Skill Paradox : Is Smarter Always Better ?

In the matter of investment forecasting skill it is often supposed that more is automatically preferable to less. In other words, the marginal utility of improving one’s forecasting accuracy is monotonically positive. However it is also commonly believed that large scale speculative capital flows (presumably driven by skilled investors) are a major contributor to financial market volatility. The consequent impact of increased volatility on the real economy imposes disutility on non-investors and this exposes an interesting trade-off between the benefits of skill improvement which accrue to investors, and the costs suffered more broadly by society. This paper constructs a formal analytic framework in which to discuss these issues, questions whether the marginal utility of skill is in fact monotonic for the individual and considers implications for policy-makers. *The authors thank Robert Kosowski and Hamish Low for many useful comments.