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The Black Swan: the Impact of the Irrelevance Or Ridiculous Exaggeration Otherwise

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The Black Swan: the Impact of the Irrelevance Or Ridiculous Exaggeration Otherwise The Black Swan: The impact of the irrelevance or ridiculous exaggeration otherwise. highly improbable. Let me run through some discussion topics, first Nassim Nicholas Taleb 6 where I broadly agree with Taleb, then 6 where Random House, 2007. I broadly disagree, then 5 final thoughts. Taleb has made his living (and a small fortune, (1) [p. 286] The sterilized randomness of perhaps transformed into a large fortune by the games does not resemble randomness in real life; 2008 market) in an unusual way { by financial thinking it does constitutes the Ludic Fallacy. speculation in contexts where he spots a small (his neologism). This is exactly right, and math- chance of making a very large gain. As with ematicians should pay attention. In my own list others who have had unusual careers (say, Neil of 100 instances of chance in the real world, ex- Armstrong or Marcel Marceau) it is interesting actly 1 item is \Explicit games of chance based to hear his experiences, but when such a person on artifacts with physical symmetry { exempli- declares I am a philosopher of ideas one is wise fied by dice, roulette, lotteries, playing cards, to be cautious (italics denotes quotes from Taleb, etc". boldface denotes my own emphasis). (2) Taleb is dismissive of prediction and mod- The phrase \Black Swan" (arising earlier in els (explicitly in finance and econometrics, and the different context of Popperian falsification) implicitly almost everywhere). For instance, is here defined as an event characterized [p. [p. 138] Why on earth do we predict so much? xviii] by rarity, extreme impact, and retrospec- Worse, even, and more interesting: why don't tive (though not prospective) predictability, and we talk about our record in predicting? Why Taleb's thesis is that such events have much don't we see how we (almost) always miss the greater effect, in financial markets and the big events? I call this the scandal of prediction. broader world of human affairs, than we usually And [p. 267] In the absence of a feedback mecha- suppose. The book is challenging to review be- nism [not making decisions on the basis of data] cause it requires considerable effort to separate you look at models and think they confirm re- the content from the style. The style is ram- ality. He's right; people want forecasts in eco- bling and pugnacious { well described by one re- nomics, and so economists give forecasts, even viewer as \with few exceptions, the writers and knowing they're not particularly accurate. The professionals Taleb describes are knaves or fools, culture of academic research in numerous disci- mostly fools. His writing is full of irrelevances, plines encourages theoretical modeling which is asides and colloquialisms, reading like the con- never seriously compared with data. versation of a raconteur rather than a tightly ar- (3) Taleb is scathing about stock predic- gued thesis." And clearly this is perfectly delib- tion models based on Brownian motion (Black- erate. Such a book invites a review that reflects Scholes and variants) and of the whole idea of the reviewer's opinions more than is customary measuring risk by standard deviation: [p. 232] in the Notices. My own overall reaction is that You cannot use one single measure for ran- Taleb is sensible (going on prescient) in his dis- domness called standard deviation (and call it cussion of financial markets and in some of his \risk"); you cannot expect a simple answer to general philosophical thought, but tends toward characterize uncertainty. And [p. 278] if you 1 read a mutual fund prospectus, or a description (b) We fool ourselves with stories that cater of a hedge fund's exposure, odds are that it will to our Platonic thirst for distinct patterns: the supply you . with some quantitative sum- narrative fallacy. mary claiming to measure \risk". That mea- (c) We behave as if the Black Swan does not sure will be based on one of the above buzzwords exist; human nature is not programmed for Black [sigma, variance, standard deviation, correla- Swans. tion, R square, Sharpe ratio] derived from the (d) What we see is not necessarily all that is bell curve and its kin . If there is a prob- there. History hides Black Swans from us [if they lem, they can claim that they relied on standard didn't happen] and gives a mistaken idea about scientific method. the odds of these events: this is the distortion of (4) Ask someone what happened in a movie silent evidence. they've just watched; their answer will not be (e) We \tunnel": that is, we focus on a few just a list (this happened; then this happened; well-defined sources of uncertainty, on too spe- then this happened .....) but will also give rea- cific a list of Black Swans (at the expense of oth- sons (he left town because he thought she didn't ers that do not come so readily to mind). love him, . ). We habitually think about the And here is his investment strategy [p. 295- past in this way, as events linked by causal ex- 6]. Half the time I am hyperconservative in the planations. As Taleb writes [p 73] narrativity conduct of my own [financial] affairs; the other causes us to see past events as more predictable, half I am hyperaggressive. This may not seem ex- more expected, and less random than they ac- ceptional, except that my conservatism applies to tually were . and he calls this the Narrative what others call risk-taking, and my aggressive- Fallacy. ness to areas where others recommend caution. (5) Chapter 3 introduces neologisms I worry less about small failures, more about Mediocristan and Extremistan for settings large, potentially terminal ones. I worry far where outcomes do [do not] have finite variance. more about the \promising" stock market, partic- His writing is lively and memorable, and his ularly the \safe" blue chip stocks, than I do about examples are apposite, so that it would make speculative ventures { the former present invisi- a useful reading accompaniment to a technical ble risks, the latter offer no surprises since you statistics course, though as indicated below I know how volatile they are and can limit your disagree with his interpretation of the relative downside by investing smaller amounts . In significance of the two categories. the end this is a trivial decision making rule: I (6) Given that Taleb's thesis is already well am very aggressive when I can gain exposure to expressed by the bumpersticker \Expect the un- positive Black Swans { when a failure would be expected", what more is there to say? Well, ac- of small moment { and very conservative when tually he makes several memorable points, such I am under threat from a negative Black Swan. as his summary [p. 50] of themes related to Black I am very aggressive when an error in a model Swans: can benefit me, and paranoid when an error can (a) We focus on preselected segments of the hurt. This may not be too interesting except that seen and generalize from it to the unseen: the it is exactly what other people do not do. In fi- error of confirmation. nance, for instance, people use flimsy theories to 2 manage their risks and put wild ideas under \ra- ical matter (termites win). Similarly, \number tional" scrutiny. of deaths in different wars" is in Extremistan; Maybe not easy for you or me to emulate, but childhood deaths from poor sanitation and con- surely conceptually useful for us to keep in mind. sequent disesase is in Mediocristan. Guess which caused more deaths worldwide in the 20th cen- Criticisms tury. That's an empirical matter (poor sanita- (7) Taleb dismisses Mediocristan as uninter- tion wins). So: esting and basically attributes Life, The Uni- Extremistan is sometimes dramatic; verse, and Everything to Extremistan: [p. xix] it Mediocristan is never dramatic. But this is easy to see that life is the cumulative effect of has no necessary connection with quanti- a handful of significant shocks. Now power laws tative impact. (in the present context, distributions with power Setting aside drama aspects, the simple fact is law tails, roughly what Extremistan is; pedanti- that our minds focus on the variable aspects of cally, I am now talking about Gray Swans) have life because we don't need to focus on the non- received much attention in popular science and variable aspects. If I ask you what you did yes- popular economics over the last 20 years, and terday, you don't tell me the usual things (com- they really do arise in various aspects of the nat- muting to work, brushing teeth, breathing), you ural world, and (for different reasons) in various tell me what was different about yesterday. If I aspects of the human economic world. But my ask you to describe your dog, you don't say \four view is that legs, one tail, vocalizes by barking", you tell me (a) the apparent prevalence of Extremistan is how your dog differs from the average dog. So: exaggerated by several cognitive biases Our minds focus on variability. Ex- (b) outside rather narrow economic contexts, tremistan is, by definition, more variable each example of Extremistan in the human world than Mediocristan, so it attracts rela- is surrounded by numerous equally significant tively more of our attention. But this has examples of Mediocristan { it's just a small part no necessary connection with quantitative of a big picture. impact. In other words Taleb's assertion quoted above, Turning to (b), take any example, even a stan- like much of the popular literature, wildly over- dard \economic" one such as financial success of states the significance of Extremistan.
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