The Black Swan

2008-04-23

in Books and literature, Economics, Geek stuff, Politics, Science, Writing

Dirty machinery

Nassim Nicholas Taleb‘s The Black Swan: The Impact of the Highly Improbable is an unusual, excellent book with broad applicability. In particular, those concerned with finance or the use of mathematics in social disciplines (politics, economics, international relations, etc) should strongly consider reading it. They will probably find it uncomfortable – as it demonstrates how their ‘rigorous’ disciplines are built on sand – but they will be wiser people if they can accept that.

Taleb’s main point is that life is dominated by improbable events of huge consequence. This is obscured to us for a number of reasons: not least, because we are able to look back and construct plausible after-the-fact stories about why things turned out the way they did. Because we fail to appreciate how explosively improbable the world is, we leave ourselves far more vulnerable than our predictions suggest. Indeed, the biggest thing Taleb attacks is the very notion that we can make good predictions about the future. ‘Black Swans’ are those improbable events of massive consequence which we are able to rationalize after the fact, though we could not have predicted them before. They can be negative (the sudden collapse of a bank) or positive (the amazing success of an obscure book). They relate to the way in which the world is skewed towards extremes when it comes to things like income or the importance of a publication.

Taleb’s book consists of an odd combination of anecdote, mathematics, scholarly and literary references, personal history, and diatribes. Throughout, one has the impression of engaging in conversation with an unusually fascinating fellow – albeit one who takes special pleasure in cutting down those who disagree with him (the text ignores no opportunity for mocking and insulting economists and financial analysts, in particular).

The lessons Taleb says one should draw from an appreciation of Black Swans are noteworthy and sensible. First, we should maximize our chances of getting lucky and finding a positive Black Swan. In investment terms, that means making lots of small bets on long shots that might really pay off. In life more generally, it basically means trying new things – visiting the restaurant you never normally would, going on the blind date, seizing the opportunity to meet with the big shot publisher to explain your book idea. Second, we should minimize our exposure to negative Black Swans that can wipe us out. That means definitely avoiding standard financial instruments like mutual funds, distrusting any risk assessment based on the bell curve, and appreciating that blue-chip stocks might collapse despite decades of steady growth. His overall financial prescription is to put whatever you are unwilling to lose in US government bonds, while using the rest to make long-shot speculative bets.

It would be very interesting to see Taleb’s ideas applied directly to International Relations (the capital letters mean ‘IR the discipline’ rather than IR the phenomenon) or climate change. Within IR, there are a few dissenters who appreciate just how inappropriate all the statistics and quantitative methods being trotted out really are. They would find Taleb’s book to be confidence-boosting, whereas the number obsessed IR scholars concentrated in the United States would probably respond to it with as much anger as hedge fund managers.

When it comes to climate change, the Black Swan idea seems relevant in several ways. First, it creates a healthy scepticism about projections: whether they are for economic growth, greenhouse gas emission levels, or greenhouse gas reductions associated with certain policies. Secondly, it reveals how fallacious it is to say: “Humanity muddled through so far, therefore we can handle climate change just like any previous crisis.” Thirdly, it sheds light on scenario planning in the face of possible disastrous outcomes with unknown probabilities attached.

It is safe to say that anybody interested in how history is written or how people try to come to grips with an uncertain future will find something of value in this text. At the very least, the colourful asides provide plenty of mental fodder. At the very most, appreciation for Black Swans might significantly alter how you live your life.

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{ 10 comments… read them below or add one }

Milan April 22, 2008 at 1:17 pm

Uncertainty
The perils of prediction
May 31st 2007
From The Economist print edition

Milan April 22, 2008 at 1:19 pm

Here is a four-page summary of the book.

Antonia April 23, 2008 at 7:13 am

Thanks, I saw this in a bookshop earlier this week and was vaguely interested, now I’m much more likely to read it.

George April 23, 2008 at 3:30 pm

I miss seeing photos on your site. Why have you stopped posting them?

Milan April 23, 2008 at 3:54 pm

George,

I cannot upload photos because my laptop is broken. Hopefully, I should have a solution worked out by tomorrow. I will then post photos to accompany all these bare posts.

. May 9, 2008 at 1:55 pm

Long-range energy forecasts are no more than fairy tales

Vaclav Smil

University of Manitoba, Winnipeg, Manitoba R3T 2N2, Canada

Sir

I largely agree with the overall conclusion of Pielke et al. in their Commentary ‘Dangerous assumptions’ (Nature 452, 531–532; 2008) that the Intergovernmental Panel on Climate Change (IPCC) assessment is overly optimistic, but I fear that the situation is even worse than the authors imply.

Debate about the energy challenge of climate change has ignored several key facts about global energy and its future.

All long-range energy forecasts fail in various ways. The scenarios for 2100 in the 2000 IPCC Special Report on Emission Scenarios are risible: even if one of them were to approximate actual demand, we will remain ignorant of what its regional and sectoral composition would be a century from now — and it is this that will determine emissions of greenhouse gases. Basing policies on computerized fairy tales is inadvisable.

. September 18, 2008 at 2:41 pm

Now it lets see where the traps are:

First Quadrant: Simple binary decisions, in Mediocristan: Statistics does wonders. These situations are, unfortunately, more common in academia, laboratories, and games than real life—what I call the “ludic fallacy”. In other words, these are the situations in casinos, games, dice, and we tend to study them because we are successful in modeling them.

Second Quadrant: Simple decisions, in Extremistan: some well known problem studied in the literature. Except of course that there are not many simple decisions in Extremistan.

Third Quadrant: Complex decisions in Mediocristan: Statistical methods work surprisingly well.

Fourth Quadrant: Complex decisions in Extremistan: Welcome to the Black Swan domain. Here is where your limits are. Do not base your decisions on statistically based claims. Or, alternatively, try to move your exposure type to make it third-quadrant style (“clipping tails”).

. January 26, 2009 at 5:23 pm

Eventually, though, you do start to get the point. Taleb says that Wall Street risk models, no matter how mathematically sophisticated, are bogus; indeed, he is the leader of the camp that believes that risk models have done far more harm than good. And the essential reason for this is that the greatest risks are never the ones you can see and measure, but the ones you can’t see and therefore can never measure. The ones that seem so far outside the boundary of normal probability that you can’t imagine they could happen in your lifetime — even though, of course, they do happen, more often than you care to realize. Devastating hurricanes happen. Earthquakes happen. And once in a great while, huge financial catastrophes happen. Catastrophes that risk models somehow always manage to miss.

. January 30, 2009 at 10:39 am

Nassim Nicholas Taleb, gadfly author of The Black Swan, gives his 10 rules for surviving an unpredictable world with dignity.

1. Scepticism is effortful and costly. It is better to be sceptical about matters of large consequences, and be imperfect, foolish and human in the small and the aesthetic.

2. Go to parties. You can’t even start to know what you may find on the envelope of serendipity. If you suffer from agoraphobia, send colleagues.

3. It’s not a good idea to take a forecast from someone wearing a tie. If possible, tease people who take themselves and their knowledge too seriously.

4. Wear your best for your execution and stand dignified. Your last recourse against randomness is how you act — if you can’t control outcomes, you can control the elegance of your behaviour. You will always have the last word.

5. Don’t disturb complicated systems that have been around for a very long time. We don’t understand their logic. Don’t pollute the planet. Leave it the way we found it, regardless of scientific ‘evidence’.

6. Learn to fail with pride — and do so fast and cleanly. Maximise trial and error — by mastering the error part.

7. Avoid losers. If you hear someone use the words ‘impossible’, ‘never’, ‘too difficult’ too often, drop him or her from your social network. Never take ‘no’ for an answer (conversely, take most ‘yeses’ as ‘most probably’).

8. Don’t read newspapers for the news (just for the gossip and, of course, profiles of authors). The best filter to know if the news matters is if you hear it in cafes, restaurants… or (again) parties.

9. Hard work will get you a professorship or a BMW. You need both work and luck for a Booker, a Nobel or a private jet.

10. Answer e-mails from junior people before more senior ones. Junior people have further to go and tend to remember who slighted them.

. April 8, 2009 at 7:02 pm

Ten principles for a Black Swan-proof world

By Nassim Nicholas Taleb

Published: April 7 2009 20:02

1. What is fragile should break early while it is still small.

2. No socialisation of losses and privatisation of gains.

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus.

4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks.

5. Counter-balance complexity with simplicity.

6. Do not give children sticks of dynamite, even if they come with a warning.

7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”.

8. Do not give an addict more drugs if he has withdrawal pains.

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement.

10. Make an omelette with the broken eggs.

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