Feb 062013
 

Economist and hedge fund manager Taleb explains that rare, outlier events are not as rare would like to believe, and have such a disproportionate impact that almost nothing else counts, no matter how large a sample of the non-outlier events we see Therefore we should cultivate positive ones (see discussion of the British Spitfire in Adapt) and guard against the negative ones (the 2008 financial crisis). Rational Wiki does a good job of explaining that a black swan event from the book has three properties:

Rarity

The black swan is a rare event. It lies outside the realm of common experience and nothing in our past experience points to its possibility. A black swan is that million-to-one chance that statisticians said would never happen because it was a million-to-one chance. Of course, million-to-one chances happen 9 times out of 10.

Extreme impact

When the black swan strikes, it has a massive impact. It is two of the world’s tallest buildings being destroyed, it is a stock market crash that wipes out billions, it is a tsunami or earthquake over a major city. Not only is the qualitative nature of the black swan outside our regular experience (meaning we can’t see it coming), so is its sheer size — a single event can dominate over all other factors.

Retrospective predictability

This property explains the concept of “black swan blindness” or “black swan denial”. It is the illusion that we can actually see things coming. This is because of the narrative fallacy; our ability to construct a sensible story using only the pertinent information, happily discarding the information that wasn’t actually useful in the end. This can only be done with the benefit of hindsight — failing to understand this makes you more vulnerable to their effects.

Rational Wiki goes on the why Gaussian statics betrays us as a model when we rely on it most:

An important point of Taleb’s is his criticism of the usage of “Gaussian” normal distributions as the backbone of statistical modelling when applied to phenomena that do not seem to follow such a distribution and are instead skewed by rare, but massive outliers. He comes up with the concepts of “Mediocristan” — the realm of properties that are Gaussian in nature, like people’s weight or height — and “Extremistan,” where properties like a person’s fortune, market behaviour or success in intellectual or artistic professions are unevenly distributed, and the inclusion or exclusion of one extreme outlier can massively change the overall picture.

This can be best visualised with a quick thought experiment. Take 100, or even 1000 people and compare their heights. Even adding in Robert Wadlow, the tallest man ever recorded, and his massive 2.72 meter frame he would only take up 0.17% of the total height and would barely skew the average by a single percent. However, if you took 100 or 1000 or even 10,000 people, compared their wealth and added Bill Gates’s amassed fortune he could easily dominate the group, holding 99+% of the money in the group. As Taleb notes when discussing this particular thought experiment in The Black Swan, the other thousands in the group barely represent a rounding error in Bill Gates’s personal fortune, or the average daily change due to random economic fluctuation. It’s this particular property that leads Taleb to conclude that history doesn’t just feature black swan events, but is controlled and shaped by them almost exclusively, with the little accumulative changes making little impact in the grand scheme of things. In Extremistan, a single outlier can absolutely dominate the group as a whole.

Links below are to second edition – 2010

Paperback on Amazon

Kindle on Amazon

Also see Taleb’s recent book Antifragile

Paperback on Amazon

Kindle on Amazon

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