I live in part of the world where black swans don’t seem that unusual, but for many the idea of a black swan was unthinkable until they were actually discovered in Australia. Somewhere, I even have a hat with 32 Black Swans on it. The metaphor of Black Swans just doesn’t work in part of the world where they are plentiful but it is a strong visual idea.
“Before the discovery of Australia, people in the old world were convinced that all swans were white, an unassailable belief as it seemed completely confirmed by empirical evidence…that was disproved by the discovery of black swans.”
So what is a Black Swan?
Author Nassim Nicholas Taleb has written a book to explain the central idea of a Black Swan: The Impact of the Highly Improbable.
In his description a Black Swan is typified by 3 attributes.
- Nothing in the past can point to its possibility
- Extreme Impact
- Even so we can somehow explain this by hindsight after the fact -( I believe this is called a confirmation bias in investment circles.)
It is an interesting idea and best of all, you don’t have to read the whole book to get the arguments – you can read a much shorter manifesto by Taleb called Few & Far Between which has been made available on www.ChangeThis.com and here as well. (16pages version) download your copy free above.
Taleb makes some good points about our blindness with respect to randomness and the ability we have to ignore large deviations or outliers – when I suspect he is more interested in the outliers.
The metaphor got me thinking about complexity theory and fractals where patterns become evident if you sweep wider enough to see them. So perhaps the patterns are always there; but our frame of reference is focused too much on the micro to see the true significance of the macro.
The idea that you can’t predict a Black Swan seems self defeating – or that in hindsight you can somehow explain the linkages. That we need to be looking much widely at impact points is a key point that is not quite made; but should be.
Larry Elliot seems to like the idea of Black Swans and markets..and knows more about maths than I do.
“Taleb is a fan of the Polish-born French mathematician Benoît Mandelbrot, who gives short shrift to those who believe financial markets resemble a bell curve, with modest movements the norm and violent moves infinitesimally rare. Looking at the daily movements of the DJIA from 1916 to 2003, Mandelbrot said that according to the bell-curve analysis, there should have been 58 days when the Dow moved more than 3.4%, when in fact there were 1,001.
Only once in every 300,000 years should there have been a day when the Dow moved by 7% or more, but it happened 48 times. “Extreme price swings are the norm in financial markets – not aberrations that can be ignored,” Mandelbrot argues in The (Mis)Behaviour of Markets
It seems highly unlikely that this has been built into market thinking. That, of course, is precisely Taleb’s point”.
For alternative view on the Black Swan book check the review by Giles Foden who wasn’t quite convinced. I particularly like this mangling of metaphors that Foden highlights below – turkeys are like swans etc…..The paragraph is so good I can see it becoming part of a stand-up routine in the next comedy festival.
It is the silence – the gap – the missing energy in the historical system, which produces the black swan. Imagine, says Taleb, the problem of turkeys: “Every single feeding will firm up the bird’s belief that it is the general rule of life to be fed every day by friendly members of the human race ‘looking out for its best interests’, as a politician will say. On the afternoon of the Wednesday before Thanksgiving, something unexpected will happen to the turkey. It will incur a revision of belief.”
Ray Poynter notes that that the book has good and bad parts and his post is one of the best on the Black Swan concept. Ray is something of an expert on advanced quant (statistics) and his excellent review is very thorough.
One of the good points he noted about the book was.
“When Taleb talks about luck and randomness he is onto something very important and under appreciated. In order to succeed you need to be good and lucky.
When we analyse the success of something or somebody, we often pay too little heed to luck and therefore too much to what they actually did. If we accept that random events play a role in success, then we should assume that, even in theory, we can’t create a model which fully measures and predicts how to be successful.”
He also points to NYTimes review and two others.
I’d be interested to know what you think of the Black Swan concept?
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Taleb has obviously been reading his Bertrand Russell. The ‘black swans’ story I believe comes from Russell, and the turkey example definitely does (the turkey story is one of Russell’s most famous). Both are illustrative of the philosphical problem of ‘induction’, deriving statements of the ‘many’ from observations of the ‘few’. Deduction works the other way around, and is therefore a ‘closed’ system.
Financial markets are ‘open’ and ‘inductive’in character, which makes them difficult to predict. It is obviously a mistake to treat something as ‘closed’ and ‘deductive’ when it is actually ‘open’ and ‘inductive’.There are problems however I think in treating financial markets as pure mathematical systems. This approach leaves out ‘economic fundamentals’.
Taleb claims that “This is an essay expressing a primary idea; it is neither the recycling nor repackaging of other people’s thoughts”.As both his central metaphor of ‘black swans’ and the turkey story suggest, this is not the case. He appears to be simply re-warming the old philosophical problem of induction, which has much concerned philosophers since David Hume. Taleb might also do well to remember the down-to-earth definition of risk offered by a Nobel Prize winning economist: ‘Risk means more things can happen than will happen’.”
Thanks Roger, Hmmmm… seems Taleb has borrowed quite heavily from Mr Russell. Hadn’t realised the turkey story was also in that category.
Perhaps his publisher wants to crank up the “long tail” and also stimulate sales of his first book which seems much better by comparison “Fooled by Randomness”. Thanks again
I think markets are well used to black swans regardless of the bell curve analysis. Risk models are constantly being recalibrated to take into account new events such as Long Term Capital Management blowing up
Could Google blow up? Who knows. I think Black Swans tells us that anything is possible and as a former trader myself i can attest to that. So far though the sun still comes up every morning…at least i hope so 🙂
Just found this intriguing piece by Nassim himself on the joys (or not) of editing and being edited. There have been a number of comments about the editing on ‘The Black Swan” and here is what Taleb has to say on the subject from his notebooks.
“I just had to withdraw a piece from publication. The copy editor wanted to “improve” the sentences. I pulled it out immediately upon hearing claims that she represented the “general public”, with the assumption that she knew what the “general public” needed –not realizing that she was talking to an empiricist who despises impressions (based on anecdotal evidence) & pompously stated superstitious.
There is an expert problem with copy editors particularly when they are self-appointed representatives of the “general public”. (“Advice” from book editors reminds me of Warren Buffet’s comment about people in limos taking stock tips from people who ride the subway). Fooled by Randomness was not copy edited (with close to 200 typos in the hardcover edition). My next book (post-TBS) will NOT be edited. An edited text is fake. Really fake. It is as shameful as ghostwriting.
Raw literature used to resemble speech, in its messiness, idiosyncrasy, (& charm). Spelling was only made uniform very late, by printers, not by authors –which explains the idiosyncrasies of medieval authors.
This ethical stand means that I will not be able to publish Op-Ed, book reviews, etc. in the “general public” and academo-philistine press. I am now left to myself –and the web.
from http://www.fooledbyrandomness.com/notebook.htm just above no.48 in his very arcane list of meanderings
Malcolm Gladwell wrote about Nassim’s first book at (2002 in the New Yorker) See April 22 & 29, 2002
http://gladwell.com/2002/2002_04_29_a_blowingup.htm
He lives in a four-bedroom Tudor with twenty-six Russian Orthodox icons, nineteen Roman heads, and four thousand books, and he rises at dawn to spend an hour writing. He is the author of two books, the first a technical and highly regarded work on derivatives, and the second a treatise entitled “Fooled by Randomness,” which was published last year and is to conventional Wall Street wisdom approximately what Martin Luther’s ninety-five theses were to the Catholic Church.”
What can I say Malcolm rocks and he liked this guy back in ’02
Malcolm noted that even then “Taleb, by contrast, has constructed a trading philosophy predicated entirely on the existence of black swans. on the possibility of some random, unexpected event sweeping the markets. He never sells options, then. He only buys them.” this is well before the cuirrent book was published.