World Famous Comics: The Black Swan: The Impact of the Highly Improbable
The Black Swan: The Impact of the Highly Improbable
By: Nassim Nicholas Taleb Publisher: Random House Average Rating: Binding: Hardcover Label: Random House Number of Items: 1 Number of Pages: 366 Publication Date: April 17, 2007 Release Date: April 17, 2007
Product Description: A black swan is a highly improbable event with three principal characteristics: It is unpredictable; it carries a massive impact; and, after the fact, we concoct an explanation that makes it appear less random, and more predictable, than it was. The astonishing success of Google was a black swan; so was 9/11. For Nassim Nicholas Taleb, black swans underlie almost everything about our world, from the rise of religions to events in our own personal lives.
Why do we not acknowledge the phenomenon of black swans until after they occur? Part of the answer, according to Taleb, is that humans are hardwired to learn specifics when they should be focused on generalities. We concentrate on things we already know and time and time again fail to take into consideration what we don’t know. We are, therefore, unable to truly estimate opportunities, too vulnerable to the impulse to simplify, narrate, and categorize, and not open enough to rewarding those who can imagine the “impossible.”
For years, Taleb has studied how we fool ourselves into thinking we know more than we actually do. We restrict our thinking to the irrelevant and inconsequential, while large events continue to surprise us and shape our world. Now, in this revelatory book, Taleb explains everything we know about what we don’t know. He offers surprisingly simple tricks for dealing with black swans and benefiting from them.
Elegant, startling, and universal in its applications The Black Swan will change the way you look at the world. Taleb is a vastly entertaining writer, with wit, irreverence, and unusual stories to tell. He has a polymathic command of subjects ranging from cognitive science to business to probability theory. The Black Swan is a landmark book–itself a black swan.
Amazon.com Review: Bestselling author Nassim Nicholas Taleb continues his exploration of randomness in his fascinating new book, The Black Swan, in which he examines the influence of highly improbable and unpredictable events that have massive impact. Engaging and enlightening, The Black Swan is a book that may change the way you think about the world, a book that Chris Anderson calls, "a delightful romp through history, economics, and the frailties of human nature." See Anderson's entire guest review below.
Guest Reviewer: Chris Anderson
Chris Anderson is editor-in-chief of Wired magazine and the author of The Long Tail: Why the Future of Business Is Selling Less of More.
Four hundred years ago, Francis Bacon warned that our minds are wired to deceive us. "Beware the fallacies into which undisciplined thinkers most easily fall--they are the real distorting prisms of human nature." Chief among them: "Assuming more order than exists in chaotic nature." Now consider the typical stock market report: "Today investors bid shares down out of concern over Iranian oil production." Sigh. We're still doing it.
Our brains are wired for narrative, not statistical uncertainty. And so we tell ourselves simple stories to explain complex thing we don't--and, most importantly, can't--know. The truth is that we have no idea why stock markets go up or down on any given day, and whatever reason we give is sure to be grossly simplified, if not flat out wrong.
Nassim Nicholas Taleb first made this argument in Fooled by Randomness, an engaging look at the history and reasons for our predilection for self-deception when it comes to statistics. Now, in The Black Swan: the Impact of the Highly Improbable, he focuses on that most dismal of sciences, predicting the future. Forecasting is not just at the heart of Wall Street, but it’s something each of us does every time we make an insurance payment or strap on a seat belt.
The problem, Nassim explains, is that we place too much weight on the odds that past events will repeat (diligently trying to follow the path of the "millionaire next door," when unrepeatable chance is a better explanation). Instead, the really important events are rare and unpredictable. He calls them Black Swans, which is a reference to a 17th century philosophical thought experiment. In Europe all anyone had ever seen were white swans; indeed, "all swans are white" had long been used as the standard example of a scientific truth. So what was the chance of seeing a black one? Impossible to calculate, or at least they were until 1697, when explorers found Cygnus atratus in Australia.
Nassim argues that most of the really big events in our world are rare and unpredictable, and thus trying to extract generalizable stories to explain them may be emotionally satisfying, but it's practically useless. September 11th is one such example, and stock market crashes are another. Or, as he puts it, "History does not crawl, it jumps." Our assumptions grow out of the bell-curve predictability of what he calls "Mediocristan," while our world is really shaped by the wild powerlaw swings of "Extremistan."
In full disclosure, I'm a long admirer of Taleb's work and a few of my comments on drafts found their way into the book. I, too, look at the world through the powerlaw lens, and I too find that it reveals how many of our assumptions are wrong. But Taleb takes this to a new level with a delightful romp through history, economics, and the frailties of human nature. --Chris Anderson
Black Swans and Systemic Risk? In my opinion, of all the characteristics that define economic activity, connection is the most important. Institutions considered "too big to fail" are in reality "too connected to fail." The web of interdependencies that girdles the globe, linking the boardrooms of Wall Street to the kitchen tables of Main Street, can be the economic system's greatest vulnerability - as Nassim Taleb argues in The Black Swan - or its greatest strength. Job No. 1 for leaders of the world's financial institutions and market-regulating bodies is to design the architecture of systemic connection to assure strength.
Laurent Pacalin Chief Marketing Officer at FICO
The Black Swan - A must read for compliance and risk professionals The title of the book comes from the observations of Europeans that all swans are white. Much to their surprise, they came to Australia and found their first black swan. The book starts with this story to illustrate the "limitations to our learning from observations or experience and the fragility of our knowledge." As Taleb points out, it very different to think there is evidence of no possible black swans, than there is no evidence of the possibility of black swans.
Taleb has received lots of press and admirers given the recent meltdown in the financial markets. The book was published in 2007. Taleb seems to have perceived the coming collapse (and probably got a rich financial reward based on his strategy).
His supreme self-confidence (arrogance) shines brightly through in his writing. He has little time for shallow thinking and those who think they understand risk or the financial markets.
Another example running through the book is the first 1,001 days of a turkey's life. For a 1,000 days the farmer brings food to the turkey every morning. On that last day, things change dramatically. The farmer shows up with an axe instead of food. A surprise and horrible change in circumstance for the turkey. But all the historical evidence for the turkey indicated that the farmer would show up with food and not an axe. Of course, on the flip side, the farmer saw the axe day coming.
As Yogi Berra philosophized: "It's tough to make predictions, especially about the future."
It is the unknown unknown that is most dangerous. We spend too much time focusing on knowing what we know. We need to spend focusing some energy in realizing what we do not know and what we do not know what we do not know.
As a compliance and risk professional I was particularly intrigued by the story of the four largest losses by casinos. As you might expect, casinos run very thorough security programs, compliance programs and risk management programs. The four largest losses fell completely outside the casinos' models. One was the white tiger's attack on Roy, the second was a disgruntled contractor who attempted to dynamite the casino, the third was the kidnapped daughter of a casino owner, and the fourth an incompetent employee who failed to file the 1099 reports with the Internal Revenue Service.
It is also important to draw the distinction between positive contingencies and negative contingencies. The black swan can be one that brings unexpected destruction or one that brings an unexpected windfall. His philosophy is to play it safe, but hedge for a disastrous losses and spectacular windfalls. Mitigate the unexpected consequences.
I expected to get a lot of insight from the book. But it was one of the few books that changed the outlook on my profession.
Opportunities and threats in improbable events I loved Nassim Nicholas Taleb's earlier book Fooled by Randomness, and I am really loving the Black Swan as well. It has much of the charm of Malcolm Gladwell's current NYT best seller, Outliers. -- But while Gladwell leaves us with merely the understanding that the success of various prominent individuals such as Bill Gates or Steve Jobs is due largely to the "luck" of being born in the right place and at the right time, he gives us no greater insight into how a better understanding of luck (in the form of randomness and improbability forces at work upon us) might better guide us in choosing national and international policies or even actively choosing our life paths taking into consideration the improbable events such as birth date and birth place work that for our success as well as those that against it.
In contrast, Taleb's The Black Swan sets its sights on providing us a theory and method to make such decisions in a way that better recognizes the role of randomness in our lives. Even more, it also shows us s that any theory which simplifies real world complexity enough for us to see patterns also inherently blinds us to the risks hidden in the messy real world complexity which we have now simplified out.
Gladwell tells us that random chance defines our opportunities and the threats we will face; Taleb tells us how to seize the random opportunities that might occur in our lifetimes, and how to prepare for the improbable but catastrophic events that surely will happen someday and often change our lives in unimaginable ways.
To fully appreciate the Black Swan, it is useful to see how it builds upon insights set out in Taleb's previous book, Fooled by Randomness.
Fooled by Randomness highlighted the failures of Wall Street market makers who mistook the correctness of their string of predictions as a sign of their own genius, rather than just random chance -- at least until the financial markets changed and suddenly their predictions were consistently wrong and their were suddenly hoisted on their on petards. In Fooled by Randomness, Taleb points out an old investment scam where an investment advisor sends out 2^12 (4096) free investment newsletters predicting that the market will be up next month, and sends out another 2^12 free newsletters to other people predicting that the market will be down next month. Let's say the market is down. Now the broker removes all the people he sent the (wrong) up prediction from his list. But he takes the four thousand plus people to whom he sent the (correct) down prediction newsletters into two parts and he send half another down prediction, and the other half an up prediction. A month later the market is up -- and over two thousand people have seen this investment advisor make the right pick twice. So now he divides that group that got the two right picks into two halves and sends 1024 people an up prediction and the other 1024 the down prediction. Every month he drops off the half of his mailing list that got the bad pick that month , but the remaining half has seen him make one right pick after another! At the end of a year he has one newsletter recipient who has seen him make 12 correct picks in a row. That investors know the probability of 12 correct picks in a row is very low1 / 2^12) so they conclude that it isn't chance a lone that makes him a great stock picker -- they conclude he is a genius, so the invest a bunch of money with him, and tell all their friends to as well.
While the sham newsletter is a well known scam, in Fooled by Randomness, Taleb points out it doesn't require such an actively deceptive strategy to make 12 correct guesses in a row. Given enough investment advisors independently guessing each month's market direction at random, say some number greater than 8096, one or two will surely make 12 lucky guesses in a row. And in fact, when we say they make their predictions randomly, we don't mean that they don't have a method -- maybe they read tea leaves, counted sun spots or compared the month's average temperature in Jackson Hole, Wyoming versus than the average for the month over the last 20 years. As long as these methods are independent, distributed widely, and uncorrelated with the actual factors that drive the market, there will still be a few lucky winners who will get it right. But now their results will be shown in Morningstar or Consumer Reports, and people will think that given their past track record was so good, so will their future be equally good! But because actually these were just random correlations, their futures aren't always so rosy.
The point of Fooled by Randomness is that these investment advisors not only fooled unsophisticated small investors into thinking that they were brilliant (rather than just lucky and later unlucky), but they fooled their superiors at the trading firms, the financial press, and themselves as well. So all of these people were unprepared when the wheel of chance turned again -- this time against them. This sets the stage for the Black Swan -- not merely should we realize that we are prisoners of a chaotic environment full of randomness, but we should also realize that we actors in this environment and can use our improved appreciation of uncertainty to better shape our destinies.
In The Black Swan, Taleb tackles how to take advantage of the deliberately take advantage of improbable, but not impossible events, not by being smarter about when they will happen, but simply by embracing randomness and the impossibility of making the right prediction in the next moment but also the certainty that ultimately the unlikely even will happen. He draws on a wide range of historical events that seemed unpredictable in advance -- from the world of war, to big finance, to individual career decisions to illustrate the breadth of application of this theory.
Taleb's appreciation of this theory and how to apply it goes much deeper than typical applications of this theory in business and economics.
For instance, we are all familiar with one major financial industry built on a probabilistic understanding of an event which is unlikely in the next moment, but which in the long run becomes increasingly certain: namely Life Insurance. When we buy life insurance we are essentially making a bet -- we are betting that we will die so much sooner than our remaining life expectancy that our estate will make a bigger return on paying our premium to the insurance company and collecting the value at our death, compared to what we could earn if we just put that same amount of money into some other investment (e.g. an S&P index fund) and watching it grow ourselves. Of course the Insurance company uses actuarial charts and its expectations of future investment returns to calculate a premium that will be sufficient to earn it a healthy profit over time. Yes, the Black Swan underlies this business, but the beauty of Taleb's analysis of the Black Swan is to see that this thought process can be applied to other things as well. Should you work at a "stable" middle of the road salary job for you life? Or should you take a high risk series of high risk / high reward jobs in the hope of hitting it big?
If you live in California, should you stockpile emergency supplies in San Francisco and LA to sell immediately to unprepared homeowners after the next big earthquake hits? How about stockpiling goods in Miami for unprepared Florida coast homeowners hit by the next hurricane?
Thinking about the Black Swan can give you some insight into some of these questions, but they can also give you some insight about the eventual failure of most any institution built to profit on them too. What are your estimates of frequency/probability and magnitude of the catastrophe or subsequent profit opportunity based on? Their frequencies and magnitudes in the past? If so, how much do they reflect all the uncertain ways that the past might be different from the future.
What if global climate change occurs, and the homes you were prepared to supply after a hurricane are now permanently abandoned and under water due to rising sea levels? Or what if a small asteroid hits the Pacific plate off the California coast: instantly releasing the pressure along the entire San Andreas fault -- but also creating a huge Tsunami that wipes out the large portions of San Francisco and Los Angeles. Did your model take these unlikely events into consideration? What other possible events are missing from our oversimplified models?
For all of the above reasons, I find The Black Swan a book of timeless value. But ironically it is also a book of very timely value.
As we watch the unfolding aftermath of a global credit crisis that even former Federal Reserve Chairman, Alan Greenspan, admits that he never thought possible, the Black Swan theory is a great guide: It was not the stupidity of regulators and central bankers, nor the greed of bankers, investors, and prospective homeowners that caused such a precipitous turn of events -- rather it was our reliance on models that simplify complex processes enough that we can understand them and predict them MOST of the time -- and our failure to distinguish MOST of the time from ALL of the time. In particular, investors and regulators failed to anticipate the risks of the Credit Default Swap market and subprime mortgage crisis can be tied to an unreasoning belief in the power of DIVERSIFICATION in the standard investment MODEL to eliminate major risks. Diversification works MOST of the time, because most of the time institutions and individuals default on loans for reasons that are largely individual, or that at worst affect only a local or regional economy or just one industrial sector of an economy. That is, these defaults are mostly independent of each other. So at any given time some subgroup is affected and default rates in that group might be higher than normal, but some other region or sector is growing and default rates there are lower -- therefore if you diversify widely enough, the standard investment risk models says you should be safe from large swings in the average value of your portfolio.
That is of course only true as long as the assumption or model is based upon -- that failures and loan defaults are INDEPENDENT of each other -- is still true.
And historically, independence of events has been a pretty good assumption to make. In 1900, if a shipper of grain in China lost a ship full of rice due to a severe storm at sea while it was on its way to Japan, his loss might affect the farmers that grew the grain in China, the merchants who were going to sell the rice in Japan, and perhaps even the fishermen who were going to buy and eat the rice in Japan. But that loss was almost assuredly independent of whether a shipload of leather sent by train from cattle ranches in Wyoming reached shoemakers in Boston.
But the world of finance and commerce today is very different. There are multinational corporations with revenues that exceed the Domestic National Product of more than 100 countries. There are multinational financial institutions which finance and insure these companies, and their are investors who seek to diversify their risk worldwide by investing outside their own native countries. There are financial institutions that have lent so much money to so many companies around the world that if they were to pull their loans in millions of jobs would be lost overnight, And they have also borrowed so much of this money from other financial institutions that if they were to become bankrupt overnight, then 100s of of lenders would no longer be solvent either.
With all this interconnected borrowing and lending, buying and selling, saving and investing among people all around the world -- all connected by fiber cable trading systems that literally work at the speed of light, we have become more INTERDEPENDENT, not INDEPENDENT. And because of that interdependence, there is a greater possibility that some large shock could suddenly affect players all around the globe and in all kinds of industries, thereby undermining our assumption of independence. So instead of being like random waves where crests colide with troughs, and troughs with crests dampening the magnitude of each and cancelling each other out, these impulses become synchronized waves whose crests intersect with crests, and troughs with troughs to amplify themselves to even larger crests and troughs like a tsunami. Soon the entire world's financial structure and economies are at risk of a simultaneous shutdown.
The occurrence of such an alignment may be infrequent and its likelihood improbably, but the magnitude when it does hit can be devastating, and all the more so because we failed to distinguish the improbable (the Black Swan) from the impossible and so we did not prepare for it at all.
If we all better understood the theory of the Black Swan, as well as its application to our own daily life choices, we could all profit more from unlikely events, and better prepare for the dangerous Black Swans that threaten to wipe us out.
Taleb deserves great credit, as a philosopher (his preferred vocation), psychologist, sociologist, financier, economist, mathematician and engaging author for establishing a powerful highly explanatory model, and a language and framework for further analysis. This is not merely an epistemological model of what we can know and what we cannot. It is a powerful model of how we can identify what we cannot know, and the how the means we use to systematize what we know blind us to risks from what we do not know.
Judged as a work of philosophy it surely will rank with both Wittgenstein's earlier work (Tractatus Logico-Philosophicus) and his later (Philosophical Investigation)s in terms of a crystallization of how our models of the world define us and limit us in what we allow ourselves to perceive; but as a work of literature he does this with far more wit, charm, entertainment and erudition.
Kudos to Nassim Nicholas Taleb on another insighfult book, for his exceptional view into randomness how it forms mankind's greatest capabilities and greatest limitations, and for his ability to explain so much complexity so simply, in a way accessible to us all.
Not for stock pickers; humanism is a religion It's nice the book is not a sales pitch for his favorite fund. Around 16% of the pages in the book touch the topic of investing, trading, or markets. I consider pages 43, 73, 97, 124, 205-207, 223 to be the most useful. I'm not sure how to profit from rare events if the events are rare. As a paid critic, the author has improved his craft. He is critical of others on pages 105-106, 133, 148, 150, 151, 154-155, 164, 165-166.
The author is a humanist (p272). Around 14% of the pages of the book touch the topic of religion or evolution. He does not appreciate the design that goes into making a car "but it is hard to look at a computer or car and consider them the result of aimless processes. Yet they are." p170.
The book gives me the opinion that the author is bound for hell. He quotes scripture but ignores its message. Page 100 gives the story of the drowned worshipers. Using the logic presented in this story, I wonder if the dead Columbine students would now prefer having "Thou shalt not kill" be taught in schools.
The author appears weak in advance statistics. He doesn't appear to be aware of the tools used by the Quality field in its application of solving problems in industry.
The author considers psychology to be mostly present in the first 132 pages of the book (page xxviii). However, if you are interested in the psychology associated with trading, then you will find a smoother flowing story in the book "Reminiscences of a Stock Operator."
Throw away the bell curve. THE BLACK SWAN makes a single salient point: the future is largely shaped by the unexpected and unpredictable. And that thought, as simple as it is, is profound.
For many years, swans were, by definition, white. But that paradigm was shattered when a black swan, a highly improbable event, was discovered in Australia. The black swan is Taleb's proxy for the unexpected.
In America, for example, the events which have shaped our lives; the Great Depression, WWII, the JFK assassination, personal computers, 9/11, were unpredictable but changed our world forever. It is the unforeseen, not the expected, which rocks our world.
In the securities industry, there is an axiom which the law requires be disclosed to each public investor: Past performance is not indicative of future results. In other words, the unexpected happens. And yet, as a culture and as an investing public we often view the future as an extension of the past, earnestly expecting tomorrow to be much like yesterday. Why? Because most of the time, it is. And then, a black swan emerges and changes everything.
The quality of writing is uneven and in places, tedious. I find it a bit hypocritical, too, when foreign authors deride America (and our cultural idiosyncrasies which they don't understand) but certainly enjoy the wealth and fame our free markets create for them. Nonetheless, Taleb scores his central point and gives us all reason to pause and consider the black swans of our lives.
Anything Goes Trivia
Trevor
Megaton Man
