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BUSINESS/ CONSUMER Nassim Nicholas Taleb Penguin Books, 2008
Reviewed: Sean Healy, 31 January 2009 Core Thought/ Key themes • The past blinds us to the threats and possibilities of the future – we live in ‘Extremistan’ prone to randomness and Black Swans but think like we are permanently in Mediocristan a predictable world which we are not Our predictive thinking and models (econometrics single out) are woefully inadequate because they fail to alert us to unlikely but massively impactful events: Black Swans This is because most theory of predictability and risk focus the on averages and fails to significantly focus the extremities : bell curves are evil Very few people pursue practical bottom up thinking and study individual cases on their own merit in detail Nassim believes that fractals (recurring shapes/behaviours) better explain probablity Our strategies for dealing with risk are generally flawed: we should make few very major safe bets and take lots and lots of small risks to learn from
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Where can it add value to what we do for our clients • • • It reminds us not to spend our lives optimising ourselves into a sub-optimal situation: some of the accountability tools we rely upon do not come up with the next great leap forward It promotes scepticism about assumptions that are not born out by empirical proof: challenge the so called experts It reminds us not just to look at the norms within any audience or market but understand as much as possible about the
behaviours and situations at the extremes as they may become the norm It reminds us of the possibility of scalability rather than predictable diminishing returns in some situations
Most useful quotes and page references • P40 ‘Consider a turkey that is fed every day. Every single day will firm up the birds belief that the general rule of life is to be fed every day by friendly members of the human race…………… On the afternoon of the Wednesday before Thanksgiving something unexpected will happen to that turkey. It will have a revision of belief.’ P 208 see footnote on positive Black Swan businesses (e.g biotech new discovery) versus negative 9e.g. banking much less profitable than it appears) P 276 see the graph that demonstrates the profound effects of extreme trading days (seen as anomalies) in the return of the US Stock Market P 284 see summary of Taleb’s approach (open to randomness) versus orthodoxy of bell curve predictability P 296 ‘I worry more about the promising stock market, particularly in safe blue chip stocks than I do about speculative ventures – the former present invisible risks, the latter offer no surprises since you know how volatile they are and you can limit your downside by investing smaller amounts.”
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Thoughts from The Reader: One really useful thing that I’ve taken from this book has been thinking about the way we manage risk and test and learn new approaches for our clients. We bin good stuff to soon and don’t manage to new enough innovation Taleb tells us to bet big on favourites and constantly back a number of real outsiders with small amounts. Instead we over invest in the mediocre.
Here is a chart that explains what I mean. Maximise the number of As and investment in them Look to improve your Bs and put them in the A camp: bin the ones you can’t improve Constantly test out Cs (risks) to find new Bs. And so a cycle of continuous improvement rolls on.
A systematic way of managing risk and experimentation to improve our plans over time
Yr 2 A YR1 B
Yr 3 A
Other reviews (attachments) •
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 selfdeception 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
The Black Swan Theory of Chance
Are we in control of history or do we simply lurch from one random cataclysmic event to the next? Oliver Burkeman examines the black swan theory of chance.
Last year, the multi-millionaire publisher Felix Dennis wrote a book entitled How To Get Rich: The Distilled Wisdom of One of Britain's Wealthiest Entrepreneurs. It is significantly less annoying than most such works, thanks mainly to the author's willingness to admit to the sheer fun of being worth around £700m. "Five homes. Three estates. Fancy cars. Private jets," Dennis wrote, enumerating the benefits. "Chauffeurs, housekeepers, financial advisers ..." Beneath the disarming tone, though, Dennis's volume conveys the same message as hundreds of others in which the rich reveal their secrets. All argue that to make a fortune, you need certain characteristics: confidence, perseverance, and little fear of failure. The implication is clear: I, the wealthy author, possess these qualities; that's how I became rich. It seems a big and perhaps tasteless leap from Dennis's life of luxury to last week's campus killings in Virginia. But a similar logic was at work. In hindsight, after he had murdered 32 people, it was obvious there had always been something suspicious about Cho Seung-hui. He wrote violent plays, intimidated female students, and - like serial killers since the dawn of time - kept himself to himself. "Cho was crazy; plenty of people knew he was crazy; he should have been locked up," the rightwing blogger John Derbyshire wrote at National Review Online. This kind of armchair smugness is the special preserve of rightwing bloggers. But the error it embodies is far more widespread. We are chronic explainers: once an event has occurred, we hurry to create a narrative that makes it look as if it was predictable. But what if we could never have predicted that Cho's life would unfold differently from those of all the other taciturn
loners? Likewise, on what grounds can Dennis attribute his success to perseverance and boldness - rather than, say, dumb luck? Hundreds of thousands of people, surely, display the same qualities, yet they don't reach the same heights. This is the central mystery that preoccupies the essayist and former Wall Street trader Nassim Nicholas Taleb. Why are we so bad at acknowledging life's unpredictability? Things happen, and surprise us. Afterwards, we act as if they were explicable all along. Then we use those explanations to pretend we can control the future: act boldly, and you'll become rich; keep an eye on loners, and you'll prevent massacres. "There's just much, much more luck than we think," Taleb says, rocking excitably on his chair in a London cafe. This is not just an amusing quirk of human nature: it matters. It explains, among other things, why a campaigner who suggested reinforcing aeroplane cockpit doors prior to 9/11 would never have prevailed - and thus it explains, in a sense, why 9/11 happened. It explains why City high-flyers receive vast bonuses, based on the unprovable belief that they possess unique skills. And it may have explained the insouciance of a sea captain, quoted by Taleb, who reportedly wrote in 1907 that "I never saw a wreck, and nor was I ever in any predicament that threatened to end in disaster of any sort." On the basis of experience, this captain might have concluded, he didn't need to worry too much about future journeys. Five years later he commanded a liner that set sail from Southampton, bound for New York, with 2,208 people on board. The seas off Newfoundland were icy. You know the rest. According to Taleb's new book, The Black Swan, life is infused with unpredictability. Almost everything really significant that happens - in the grand sweep of history, or in our personal lives - is what he calls a black swan event. The label evokes an old philosophical observation: you might believe in the truth of the statement "all swans are white", but no matter how many white swans you see, you can never prove it for certain. On the other hand, a single, unexpected sighting of a black swan completely disproves it. Black swan events are shocking when they happen, and their impact is huge - but in retrospect, they seem predictable. The September 11 attacks were a black swan; so was the Virginia massacre. And black swans, Taleb argues, are getting worse: in our global, electronically connected world, randomness is magnified. Things spin more rapidly out of control, whether copycat killings, or sales of Harry Potter books. We can't get much better at predicting. But we can get better at realising how bad we are at predicting. Taleb has the dubious honour of having inspired the former US defence secretary, Donald Rumsfeld, to make his speech about "unknown unknowns". (He had outlined his ideas to Rumsfeld's aides some time earlier.) "But I don't want to be advertised as someone who's too close to these people," Taleb sighs today. Rumsfeld's "unknown unknowns" speech made perfect sense. The problem, Taleb says, was that Rumsfeld himself didn't understand it. The black swan way of thinking should have prompted the defence secretary to be cautious about his capacity to predict the future in Iraq. Instead, he fell, again and again, into the prediction trap. If you are aware of your own ignorance, though, you can use it to make money, as Taleb did on Wall Street, as an options trader. Options are gambles about what the market will do. To sell an option to somebody else, you need to be confident you have some kind of theory about what will happen in the future. If you're right, you make a small amount of money; if you're wrong, you lose lots. Taleb, however, realised he had no theories. So he exploited everyone else's confidence, buying options according to no particular prediction. Most days, his rivals made a small amount of money, and he lost a small amount. But the one thing he could predict was that, if he waited long enough, something unpredictable would happen. When it did, some of his rivals would lose millions, and Taleb would make millions. It happened often enough for him to turn a big profit. It takes a rebellious nature, and an iron stomach, to go against the flow for so long. It is, perhaps, the kind of mindset that comes naturally to someone who lived through the Lebanese civil war - a classic, unpredictable black swan - and then found himself living as an exile, at one remove from American society. We
are not all so good at resisting the herd's way of thinking. Take, for example, this article. It is ridiculous for me to suggest, off the cuff, that Taleb's experience of the Lebanese war, or being an exile, made him who he is today. I haven't located a sample of other exiles, or other Lebanese people, in order to calculate the rate at which they become mavericks like Taleb so what do I know? This is the kind of thought liable to make a journalist question his career choice. You actually reduce your knowledge by consuming news, Taleb argues, because the media can not filter out the vast majority of facts that turn out to be irrelevant. Besides, for reporters, the temptation to make things look explainable in retrospect is irresistible. Taleb recalls the alert that flashed up on Bloomberg News when Saddam Hussein was discovered hiding in a hole: US Treasuries Rise; Hussein Capture May Not Curb Terrorism. But treasury bonds fluctuated that day; they usually do. Half an hour later, they were down, and a new Bloomberg alert flashed up: US Treasuries Fall; Hussein Capture Boosts Allure of Risky Assets. After all, there had to be a sensible reason why the price had changed, didn't there? And so Bloomberg found one. Saddam's capture had caused the price to rise. Or fall. One of the two. History begins to look strange when you see it in black swan terms. Irwin, the young teacher in Alan Bennett's play The History Boys, urges his students to think about "the moments when history rattles over the points" - times of spine-tingling potential, imbued with the feeling that things could go in radically different directions. ("When Chamberlain resigned as prime minister, Churchill wasn't the first thought," one of the boys muses, playing along.") Irwin's real-life inspiration, The Scottish-born historian Niall Ferguson, is largely responsible for the growing profile of "counterfactual history" - the enterprise based on asking "what if?" What if (to be a little more frivolous than Ferguson would allow) the Archduke Franz Ferdinand's driver had taken a different route through Sarajevo? What if an aspiring Austrian painter named Adolf had found success as an artist? "We see a great event like the first world war, or even a not-so-great event like the Virginia Tech shootings, and we think, 'Gosh, that must have had commensurately great causes, let's go and find them,'" Ferguson says. "So we find the role of German naval building, or colonial rivalries, but the problem with that approach to historical explanation is that no contemporaries saw these chains of causation leading to global war ... It's perfectly possible for an event as large as the first world war to have had quite proximate, small causes - that an assassination in Sarajevo really could cause four and a quarter years of carnage." Marxist-influenced historians, predisposed to view history as the unfolding of economic structures, have long disdained this approach: EH Carr called it a "parlour game"; EP Thompson called it "unhistorical shit". If you are no longer anchored to what really happened, don't you just float free into aimless speculation? "If you look at major historical events, the outcome is not random or simply contingent," says the (non-Marxist) historian Ian Kershaw, whose latest work on the second world war, Fateful Choices, has a counterfactual flavour, though he rejects the label. "There are developments which predispose the outcome, and the job of the historian is to work out what are the predisposing elements, and what is truly contingent." In January 1933, there were lots of reasons why Hitler was likely to come to power: that outcome was predisposed. But it wasn't certain: there were things that President Hindenburg could have done to stop it. We can debate how far to carry black swan thinking in history. What seems certain, though, is that we could all do with applying it more in our own lives. This week, reporters thronged to the door of Alec Holden, from Surrey, who had placed a bet that he would live to 100. Now that he had won the bet, the media had one question: what was the secret of his longevity? Eating porridge each day, Mr Holden replied. And taking holidays, and not worrying about things. It makes sense. Then again, how many people do all those things, but die much sooner? And what of the alternative explanation sometimes offered by the very old: that a little of what you fancy - gin, cigars - does you good? That explanation makes sense, too. Then again, it might all be chance. The point is that we cannot know. The least we could do is admit
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