Author: Cetin Hakimoglu Date: 12/11/2012 Bio: use the one on file Title: Taleb's Own Black Swan

Nicholas Nassim Taleb rose to prominence not only by coining the term Black Swan s aforenamed book, but through his fund Universa which allegedly doubled its cap ital during the 2008 crash using black swan trading methodologies when the broad er indices (and most funds) were down 30-50%. From what I gleaned from various b ooks Taleb uses a barbell or tail hedging strategy of buying out of the money ca lls and puts to capture positive and negative black swans. The remaining 90% or so of his capital is allocated to risk free assets (like treasuries). This metho d has been portrayed as some sort of holy grail, when it is merely a strategy an d hence its success is conditional upon various external factors. If the market falls a lot (like what happened in 2008) his fund will make a lot of money exer cising the put options. Otherwise, he loses only a small amount of money when th e options expire worthless. His fund is able to tolerate small, repeated losses for a huge potential payday when a black swan materializes whereas traditional funds would be destroyed by the black swan. The definition of that black swans are rapidly unfolding, unexpected events that have drastic ramifications. But no one has considered the possibility of 'slowmotion' black swans or black swan events that unfold slowly and inexorably as to be imperceivable, but the final outcome (either good or bad) just as substantia l as a normal black swan. Consider an unfortunate astronaut that drifts into the event horizon of a supermassive black hole. At this point there is no escape an d he is doomed, but since the density of a blackhole is inversely proportional t o the square of the mass, for a very massive large black hole the astronaut does not feel pressure from the immense gravity even though he's falling at the spee d of light. As he approaches the singularity spaghettification will occur, but f or a sufficiently large blackhole this may not occur for a very long time. The a stronaut remains entirely oblivious until shortly before his death. http://www.mybudget360.com/wp-content/uploads/2008/12/7-short-term-interest-rate s.png From chart above the optimal time for employing Taleb's strategy would have been in the late 80's, late 90's and late 2000's when short term interest rates were high and stocks were much more richly valued. We're now almost five years into Bernanke's 'ZIRP' policy; never before have short term rates been as low as they are now for as long and I would be willing to wager they will remain this low f or the remainder of the decade. Meanwhile, the PE ratio of the S&P 500 is still only 13 versus 20 in 2007 and 40 in 2000 . This is not only a black swan, but a slow motion one. Taleb's constant complaining about the fed, Wall St. and 'fragile' policy is pos sibly motivated by a desire to see the market go lower to reap large profits. Th e irony is that the 'anti-fragile' approach to fiscal and monetary policy would cause a black swan (a big bear market). The market has already fallen as much as ten percent from it's recent highs in anticipation of a potential fiscal cliff induced economic slowdown; should Taleb's wishes be granted the downside would b e considerably more. 'Reckless' fed policy may have caused the crisis, but the p oison is now the panacea. An overabundance of domestic and foreign treasury purchases, a flight to safety exacerbated by heightened market anxiety, and endless quantitative easing progra ms are depressing short term rates whereas just a decade ago under conventional macroeconomic rules short term rates would be much higher at this stage of the e conomic recovery. Aggressive fed interventionism not only helps smooth volatilit events brief in duration and rare but the low interest rates y by keeping black swan in hi

makes it nearly impossible to recover the repeated small losses from out of the money options, and eventually these small losses will add up to a substantial am ount of money if a black swan doesn't happen. Unfortunately, the methodology of Taleb's trading is still opaque, so we have no way of knowing how much market up side or downside is required for his bets to hit paydirt. In a 2012 column he sa ys he own stocks and he considers treasuries unsafe. Perhaps he was referring to his own personal investments which as differences from that of Universa. Perhaps perpetually low yields and an absence of market volatility could technic ally be a black swan from the perspective of Mr. Taleb.