The Black Swan in everyday life

03 Jul 2010

I’m a big fan of Nassim Nicholas Taleb’s book The Black Swan, about surprising events and why we think we can foresee them, but we actually can’t.

The title comes from an old philosopher’s point, that you can see a bunch of white swans, and conclude that all swans are white. But all it takes is spotting one black swan—and they actually do exist, in Australia—to prove your idea wrong.

As Taleb describes his big idea, in an article on The Edge:

A black swan is an outlier, an event that lies beyond the realm of normal expectations. Most people expect all swans to be white because that’s what their experience tells them; a black swan is by definition a surprise. Nevertheless, people tend to concoct explanations for them after the fact, which makes them appear more predictable, and less random, than they are. Our minds are designed to retain, for efficient storage, past information that fits into a compressed narrative. This distortion, called the hindsight bias, prevents us from adequately learning from the past.

Taleb is a futures trader—or, rather, a futures buyer. When others sell options that say, “In a month’s time, you can buy a million barrels of oil from me at $90 a barrel”—or whatever they’re selling, at some future time and price—Taleb buys these up. According to Malcolm Gladwell’s profile of Taleb in the New Yorker in 2002, he buys up options that assume the market will fall—and also futures that assume market will rise.

He plays both sides because he thinks that people underestimate the chances big changes—whether up or down—in the market. People tend to imagine that the future will be like the past, that things will keep going along smoothly, more or less, and don’t have a way to conceptualize what would happen if there was a big jump, or how they might deal with it.

Taleb presents this is as a big idea, and I think it is. It’s a big reason why the economy tanked in 2008. And since he’s made money by betting that people ignore these big changes, he argues his technique can help us in general. He explains a bit in a Wired interview with economics journalist James Surowiecki:

So what do we do? If we can’t forecast the really important things, how do we act?
You need to ask, “If the Black Swan hits me, will it help me or hurt me?” You cannot figure out the probability of a Black Swan hitting. But if you’re in a business that’s prone to negative Black Swans, like catastrophe insurance, I advise you not to take your forecasting seriously — and to think about getting into a different business. You don’t want to be a sucker. What you want are situations where you can have as much of the good uncertainty as possible, where nothing too bad can happen to you.

I’m not sure how to apply this outside finance, though. Taleb’s betting strategy, it seems, relies on a zero-sum game: With his strategy, he can consistently win, almost no matter what happens; but for him to win, someone else must lose because of their ignorance.

I like his emphasis on surprises and big jumps in the world around us, and that we should be prepared. We all need to know this.

But it seems that in everyday life, the best we can do is be defensive against big jumps by not leveraging ourselves too much, not taking on too much debt, not making ourselves beholden to big bets about the future. It doesn’t seem we can profit from big jumps in any direct way, the way that Taleb does by buying options.

(Credit where due: This post was triggered by a post on Resilience Science blog, “Black Swans: expecting the unexpected”.)


books I've read on failure & grace

The World Without Us
The Last Oil Shock: A Survival Guide to the Imminent Extinction of Petroleum Man
A Paradise Built in Hell: The Extraordinary Communities That Arise in Disaster
Hell and High Water: Global Warming--the Solution and the Politics--and What We Should Do
The Worst Hard Time: The Untold Story of Those Who Survived the Great American Dust Bowl
The Tipping Point
Three Cups of Tea: One Man's Mission to Promote Peace... One School at a Time
The Upside of Down: Catastrophe, Creativity and the Renewal of Civilization
Out of Poverty: What Works When Traditional Approaches Fail
The Little Ice Age: How Climate Made History, 1300-1850
Confessions of an Eco-Sinner: Tracking Down the Sources of My Stuff
Deep Economy: The Wealth of Communities and the Durable Future
The Geography of Bliss: One Grump's Search for the Happiest Places in the World

Mason's favorite books »