I must confess to being very late to read Nassim Nicolas Taleb’s The Black Swan, and frankly had considered NOT reading it. First, it has been so widely reviewed and discussed that I had assumed the additional knowledge to be gained by reading the book itself would be marginal. Second, I’ve read a bit of Benoit Mandelbrot, who is arguably Taleb’s most important predecessor. It was Mandelbrot, a mathematician, in the 1960s, who found 100 years of cotton trading data, with daily prices. Mandelbrot cut the information every which way and found that its distribution did not at all correspond with the assumptions underpinning the new and growing school of financial economics. It was Mandelbrot that discovered “fat tails”, that very extreme price movements are far more likely than the theories predict. He also found that market have memory, that their price movements do not comport with the “random walk” theory (I have assumed this pattern somehow relates to the cognitive bias of anchoring, but do not know if anyone has been able to connect the dots).
His findings were initially rejected, and continued to be resisted even when they were replicated in other markets (and then proved out in the real world: a daily price move like that of the 1987 crash was so extreme as to verge on being statistically impossible).
Put simply, computational convenience trumped empirical findings.
Even though Taleb’s observations have gotten a lot of attention in the popular media, I sincerely doubt they will be internalized. In classic cognitive dissonance fashion, his views may be given more lip service, but it will not be integrated into mental models, even of those who ought to pay heed. The very fact that his construct has been reduced to the soundbite “black swan” when it is more complicated and richer is telling.
What are some of the reasons? Let me speculate.
First, Taleb goes to some length to establish that he is not the first to go down this line of thinking; he has quite a few intellectual ancestors. Yet these observations never took hold.
Of course, one reason is that the implications are pretty uncomfortable for a lot of professions (although Taleb would dispute their clams of professionalism). He contends that predictions are a fraught-to-useless exercise, and cites research that shows that lay forecasts are frequently no worse than those of experts. His book would appeal most to people who are well educated and interested in finance and economics. A fairly large subset of that group has invested in expensive educations and/or developed a lot of career experience to try to anticipate the future better than your average slob. Do you think a book, even a very persuasive book, is going to change how people operate on a day-to-day basis? Unlikely.
But second, and perhaps as important, people do not want to see the world as subject to chance to the degree that Taleb says it is. This is hugely unsettling if you really do come to terms with the implications of his argument. We like to believe we have some measure of control over our lives. And research has shown that people do pretty consistently overestimate their degree of control and influence (for instance, most people will exaggerate their contribution to the success of a project, not as a matter of PR, although that may be true too, but their private assessment). Most people (ironically those deemed psychologically healthy) have an optimistic bias and generally assign too high odds of things working out well (the mildly depressed make more accurate assessments. I have often wondered which way the causality runs: do they make better assessments BECAUSE their unhappy state strips away the rose-colored filter, or are they mildly depressed because they keep giving more realistic assessments, which makes them a drag to be around, and they are depressed because they encounter social rejection?). So if you embrace Taleb, you’d have to accept the disorienting fact that the world really is a pretty untractable place, that success had more to do with luck than application (although Taleb stresses the importance of working at being lucky, that is, accepting the opportunity to meet new people and make the most of chance encounters).
Third, if our mental construct of how the world works is off in some fundamental respects, it also calls into question our ability to make good decisions. And apart from Taleb, there are reasons to question our abilities here. It has been pretty well documented in brain research that humans can only hold so many variables in their consciousness at once. Our decision-making capabilities are more limited than we’d like to believe. And confronting every situation as if it were new would be simply exhausting, That is why we rely heavily on rules of thumb (more fancily called heuristics). Now we also have certain types of analytic processes, what I like to think of as pattern recognition, that can serve us well (this was the topic of Malcolm Gladwell’s Blink). The problem is that this quick pattern recognition can work very well, or be absolutely wrong, and we have no easy way of telling which.
Essentially, Taleb paints a picture of the world and human behavior that is unflattering. So as much as his work makes a fundamentally important set of observations, its success may be largely a function of luck. It came out just when the credit markets were starting to unravel and well established practices, both among traders and the broader financial community, were being shown to have serious flaws. Had his book come out at another juncture, it probably would not have been as well received.
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Actually, Talebs first popular book “fooled by randomness” came out back in 2001–well before the current market situation and in it he discussed “black swans” a great deal. Also, he had been working on the book (black swan) well before the current crisis. So no luck he had a great popular following back in 2001-2002. Note date of his new yorker profile.
His success was a la malcolm gladwell more due to hard work and good ideas than mere luck. Some sales of his work likely driven by late adopters or me toos–most of which do not follow serious ideas and just want to copy what the head herd members are reading…
You note in your otherwise fine essay thought you did not need to read and that indicates a certain cognitive bias–cant be bothered by facts and a certain mental laziness all to common in journalists
NNT
Still have to read it myself. Will be interested in finding out to what degree it discusses and/or can be applied to governance in general, including political science, and not only economics.
A voir
After Summers/Geithner using the credit crisis to justify giving handouts to banks. Their next scheme will probably be to use the economic crisis to justify giving the banks handouts, by giving them sweatheart infrastructure deals.
Martin Hutchinson says “To build better infrastructure, we need superb engineers and sober, long-term oriented, moderately paid fiduciaries. Not expensive fast-buck financiers and not governments. The problem is one of US economic structure, and it urgently needs to be solved.”
http://www.atimes.com/atimes/Global_Economy/JG02Dj02.html
Yves,
I remember as a graduate student in economics some 40 years ago receiving reams of data on exchange rates — from a very young Dr. Poole curiously enough– during a period of several years in the 1930s when countries went off the gold standard and exchange rates were largely market determined. I set out to examine the “random walk” hypothesis that basically was a derivative of the efficient market theory. It seemed to me absurd at the time and still does. The data abundantly showed trends in exchange rates based on interest rate differentials more closely correlated in the case of small countries than larger ones. It seemed clearly demonstrated in the data that exchange rates followed interest rate differentials with a lag as investors gradually made adjustments to the new market situation and as news filtered out to different market participants with varying speeds of adaptation. Hardly a random walk! One could equally well point to 20-30% movements in common stocks in the last quarter entirely without any news on the shares or company. Hardly an efficient market.
Of course disproving a theory in fad does not make for a career in academic economics so I went on to be a practicing economist a place where real world knowledge is more roundly appreciated, though not always as we have come to learn lately. Your essay well lays out the travails of being an outsider and the comforts and fundamental ingnorance of following the herd.
Let’s us not forget either that herd mentality usually has a common demoniator in class interest, if not in finding the truth, a phenomena that has been explained well by structuralism and neo-marxist sociology.
SS
Popper wrote insightfully about “one of the oldest dreams of mankind–the dream of prophecy.” NNT has been drawing attention to the abusive use of low-dimensional models and unthinking applications of statistics to non-statistical processes. Wall St models are largely sales tools, but when the music stops inventory can kill the banks and if the models diverge enough from reality the markets die, too.
This got anything to do with global warming models?
Richard
I came to this topic as someone who specialized in statistical physics in grad school in the early 1970s. The usual way to get Gaussian fluctuations is to add up lots of independent little fluctuations (the “central limit theorem”). The little ones (the individual traders in a market) have to act independently of each other, or the theorem doesn’t follow. Obviously, in real markets, the traders’ behavior is influenced by the actions of other traders. In the aggregate system, small fluctuations about the mean will still often be Gaussian, but that doesn’t mean the big ones are.
As a practical matter, non-Gaussian 1/f noise (as opposed to Gaussian “white noise”) has been well known to radio engineers since the 1920s and 1930s.
I remember being shocked at the time of the LTCM breakup when I saw a vice-chairman of the Fed (I think) quoted in the NY Times saying that information feedback is always a stabilizing factor. Any engineer who has studied control theory knows the opposite is true. The math of control theory was first developed by James Clerk Maxwell, who studied a lever arm connecting a pressure gauge on a steam boiler back to the feed at the bottom of the coal hopper (for that reason called feedback). If the pivot is too close to the boiler (too much feedback), the boiler goes into uncontrolled oscillations and explodes.
Shortly afterwards, I ran into a friend from college who had become a quant on Wall Street. I mentioned my shock at this quote. He said, of course we know that fluctuations aren’t Gaussian, but Gaussian fluctuations are the only ones we can model. We’re paid to develop models like everyone else’s models, not to develop models that are correct.
NNT,
I don’t know that you will return to read further comments, but I am flattered and honored that you chose to weigh in.
Yes, I will confess to what may amount to intellectual laziness, or perhaps more accurately, a response to information overload, having to chose what merits reading in full versus what can be inferred well enough from recountings (I will also admit to not doing what you do, unplugging from daily noise, that is a big part of the problem). However, I did in the end read the book, so I came to the correct conclusion, albeit late.
I admit to being remiss in not mentioning Fooled by Randomness but it did not capture the popular imagination the way The Black Swan did. I believe that can in part be attributed to the world providing particularly vivid (and costly) examples of your thesis.
NNT: “You note in your otherwise fine essay thought you did not need to read and that indicates a certain cognitive bias–cant be bothered by facts and a certain mental laziness all to common in journalists”(cut and pasted)
If you’re going to snark on Yves, you could at least write a coherent, grammatical, punctuated sentence.
Personally I found fooled by randomness to be a better book, the black swan seemed to rehash essentially the same themes into a slightly different context, with far greater commercial success obviously… Does that say something about consumer behaviour and herd mentality??
Regarding depressed people making accurate predictions..
In the 1980’s, did Russians make more accurate predictions before, or after their Gov. paychecks ceased to arrive in the mail? That is, in game-playing the future, when your accuracy determines the intensity of pain that you will feel, you will try harder.
In a bubble, accuracy is irrelevant because all behaviors are rewarded. In a bubble, “bubbly” personalities climb the corporate ladder and get the job of designing risk models for world-shattering, financial instruments.
That’s right, that “bubbly” person at work has come around and bit us all on the ass!
Regarding our brains capacity to manage only a small number of variables, when we game-play the future..explains why prophets, shamans and oracles are often also, categorized as schizophrenics. Chaos is terrifying, and it is disturbing to entertain too much ‘stuff’ in one’s mind.
I would argue that Taleb is unique, in that he can imagine the horrifying and the terrible, and yet still navigate successfully within conventional society.
In this manner, Taleb is the shaman for this crisis, bold-hero, unique and a wonder to behold.
Thanks for this opportunity to comment on Taleb, and no, I am not ghosting for Nicholas, but I am a depressive..:).
I found Maxwell’s paper on the web:
http://www.ee.adfa.edu.au/staff/hrp/historicalpapers/ongovernors.pdf
It seems as though the history I was taught in grad school may have been a bit embroidered… but the essence is certainly there:
If, by altering the adjustments of the machine, its governing power is continually increased, there is generally a limit at which the disturbance, instead of subsiding more rapidly, becomes an oscillating and jerking motion, increasing in violence till it reaches the limit of action of the governor.
I like Mandelbrot even better – he predates and is even more under-studied than Taleb.
A fractalist’s view of markets
Rule I – Markets are risky. Extreme swings are the norm in financial markets – not aberrations that can be ignored.
Rule II Trouble runs in streaks. Market turbulence tends to cluster.
Rule III Markets have a personality. This internal market behavior is remarkably durable.
Rule IV Markets mislead. Patterns are the Fool’s Gold of financial markets.
Rule V – Market time is relative. This trading time speeds up the clock in periods of high volatility, and slows it down in periods of stability.
Human Nature yearns to see order and hierarchy in the world. It will invent it if it cannot find it. pg 189
As will be seen, the standard theories of finance assume the easier, milder form of randomness. Overwhelming evidence shows markets are far wilder, and scarier than that. pg 23
Continuity is a fundamental assumption of conventional finance. pg 237
The (Mis)behavior of Markets – A Fractal View of Risk, Ruin and Reward, Benoit Mandelbrot
AND I suggest the Bush administration substantially manipulated and hypo-ed the ‘averages’ and simply pulled the plug upon leaving office. This went FAR beyond the market support of the ‘Working Group on Markets’
“If you’re going to snark on Yves, you could at least write a coherent, grammatical, punctuated sentence.”
So you can’t match his brain that you have to find fault in his clothes?
Maybe people more trained with statistics (and with Tversky’s et al work on cognitive bias) regards the “Black Swan” metaphor as an “usual postmodern literary suspect” the moment they hear about it and decide not to read anything.
For them (me too), many suppossedly “black swans” are just information arbitrage. Or at least there is no clear cut distinction between almost unpredictable random events and events fully predictable but under an information arbitrage condition.
A true professional should know better about the tools, their limitations and possibilities and act accordingly. So those guys at Wall Street are using statistical models brainlessly? Ok. And?
Ok, knowing that you could profit from information arbitrage, if you happen to have a better model of the reality, statistical, non statistical or mixed (i.e. those of Schiller, Magnus, Roubini…).
But as crisis develops, it is not a truly unpredictable event. It has to do much more with socio-cognitive bias and the like.
Now, for people not acquainted with those fields, surely they regard it very differently because it is a new way of thinking for them. Also, being open to syncronicity suggests links with spiritual traditions.
All in all, spiritual or not, you will lose the shirt betting Black Swans almost systematically at a poker table… unless your opponents are tight players.
Of course, you try to ‘make’ Black Swans for them, indeed. But then, again, that’s information arbitrage for you, a Black Swan for them.
(Just the point of view of someone with some training in statistics and cognitive bias, finding the metaphor interesting but, honestly, not feeling as if reading much more about it because of the abovementioned ideas and information overload. It’s not representative of general population, just of some subset).
There is some irony here deeper than I can grasp, the coherence of an absence of coherence. Something like that!
I read Taleb’s Black Swan and came away unimpressed. I think he makes a straw man and then attacks that straw man. For example, I don’t know of any theory which claims that prices of anything reflect random walks with moves from a normal distribution. For example it is immediately clear that over long periods of time most prices are mean reverting. In fact, that is what economic theory should predict. Excessively high prices incentivize investment and production of more of that commodity which acts to lower prices. This simple model explains mean reversion fairly well.
People who claim that normal distributions of price movements should follow from the central limit theorem simply haven’t read the conditions of the theorem.
Talab makes it seem like most people involved in financial markets think that major crashes are almost impossible. No one thinks that, especially people who have a basic familiarity with financial history which most major players in financial markets do.
The reasons why it seems like people don’t understand these risks is because they do not have the incentive to avoid them. For example, if a bank CEO had 5 good years and makes a fortune in salary, bonuses and stock options, he or she is not going to lose their wealth simply because the bank fails. They don’t need to give back their wealth. Same with hedge funds. The incentives always favor these people taking on major risks. If the 50 year storm comes and their business fails, they still come out a winner. Angelo Mozillo probably made more money through the boom and bust of Countrywide than he would have if he ran it Jimmy Stewart style with a 3% annual growth rate.
Taleb makes it seem like these people are completely ignorant of the risks they take but I think he is wrong there. They just have no incentive to worry about extreme events,
Yves responded to a note by someone who talks about Taleb in the 3rd person, writes sloppily, but then signs off as NNT?
Anywho…
The Black Swan is a nice fable for us. It gives us a neat explanation for what happened and why. But what about the explanation that makes most sense of all — that this, the greatest robbery in the history of the world (the “bust out”) was planned, and then executed using simple fear and greed. Study organized crime and con artists and you’ll find much more workable explanations than if you listen to the enablers.
Nice, informative post. I couldn’t get through Black Swan. Taleb makes the reader labor way too hard to grasp his very simple argument. Yup, unforeseen stuff happens more often than we might think. But most days are still like the day before, and living your life in anticipation of something you can’t foresee would be, for most, a recipe for unproductive behavior. God bless Taleb that he’s such an ardent salesman for his trendy point of view.
Lanny Nugen: “So you can’t match his brain that you have to find fault in his clothes?”
It wasn’t his clothes, it was his demeanor. But, in fact, the fashion of putting thoughts from good brains (even unmatchable brains) into clear prose seems to be falling off faster than houses. /To/ for /too/ requires rereading the sentence, and it was an unpleasant sentence to begin with.
David,
Could your last sentence also read:
“Taleb makes it seem like people are completely ignorant of the risk that they take. He is wrong. People are incentivized to be completely ignorant of the risk that they take.”
What kind of logic is that?
Richard:
For an environmental take on the difficulty of prediction try:
Useless Arithmetic by Orrin Pilkey and Lina Pilkey-Jarvis.
They are environmentalist so their arguments do not run the way you might think.
Another book, that I started, but got distracted on and have not finished is:
David Orrell’s The Future of Everything.
Hi there
I am NNT. I was not the one commenting before. I would be honored to do so had I seen the article –but someone else seems to be either using or usurping my identity, though in good faith.
Ciao,
Nassim
In my experience, markets do have memories, but the memory of a market is much more complex than suggested by the simplistic cognitive biases created by investor memories fostered by faulty anchoring.
Astute investors/traders will be fairly well aware of their cognitive biases, they will be alert to Keynesian situations of “when the facts change, I change, what do you do sir” and they will always stretch their imaginations as far as possible to embrace “knightian uncertainty” and the “highly improbable” and manage risk accordingly.
As Taleb pointed out, it is not the known risks that are most important to hedge against, but the unknown risks. While it is virtually impossible to hedge unknown risks, it does inform the investor or trader to risk very small amounts of capital on any one trade idea or investment theme. This allows one to be wrong, and have time and flexibility to adjust and adapt to unknown and unexpected events.
To your point about popular media internalizing the lessons and insights provided by Taleb and Mandelbrot, broadly speaking, no they will not. But, of that minority of successful traders and investors, yes, I am quite certain that a percentage of them have indeed internalized these lessons in their risk management profiles. Because, precisely to your point again:
“Certain types of analytic processes, what I like to think of as pattern recognition…can serve us well… The problem is that this quick pattern recognition can work very well, or be absolutely wrong, and we have no easy way of telling which.”
Another who thanks you for your time and effort. At the top of my blog list.
Re: Taleb
Nothing new under the sun.
System decay.
Human folly.
To everything turn,turn,turn
Here’s an interesting article from the latest Science. It is somewhat related to the present discussion.
Predicting Elections: Child’s Play!
John Antonakis* and Olaf Dalgas
In two experiments, children and adults rated pairs of faces from election races. Naïve adults judged a pair on competence; after playing a game, children chose who they would prefer to be captain of their boat. Children’s (as well as adults’) preferences accurately predicted actual election outcomes.
http://www.sciencemag.org/cgi/content/full/323/5918/1183
[May require subscription, but opens up on my computer]
i’ll be blunt(especially considering he appears to be posting), i find his books, including the black swan, shit.
claims events which many people predicted, were “black swans”. give me a break.
that is not to say there aren’t unforeseen events that occur to even the best, but what use is telling us unexpected events happen if we don’t know what those events are?
plus he’s a hypocrite, in practice he models.
and as engineers are taught – do not rely on models, they do not take into consideration everything, they are only models(or something along those lines).
UBMW,
For the generalist, you are right. Not so jokingly, I say that I need a forensic criminologist to understand the economy and to make investment decisions!
In his book, Taleb has introduced the image of a black swan as an unforgettable, even, beautiful symbol to stand, now, before economics and finance students forever into the future, as a reminder that everything that we are told and everything that we know MAY, in reality, be utter nonsense!
Very Socratic.
Now, how valuable is that!?
For a follow up reading (if you’re interested in complexity theory), I can recommend a New Kind of Science by Stephen Wolfram. In fact, I think Taleb should read him as well, as he improves upon Mandelbrot’s work in complexity.
The gist of what’s important in NKOS is that complexity has actually multiple types (Mandelbrotian being type 2), that it arises spontaneously from simple rules (not the chaos in/chaos out from Benoit), and that there simply are no shortcuts that can give you the outcome (ie, no theories that help predict the black swans).
Taking Taleb and Wolfram together, it’s a sobering world view, but it argues that our best approach is not to predict disasters but to react quickly and save conservatively for the inevitable. Taxes, insurance, disaster preparedness all can be characterized by this model.
My apologies to you, Nassim, my remarks were addressed to the initials at the bottom of the post. If Lanny, knowing of you, thought I was responding to you, then my apologies to Lanny also.
brushes. No, that is not the same. They are not ignorant of the risks. They are just incentivized to ignore those risk. Angeles Mozillo is the perfect example. He remains a billionaire. How can you say he did anything wrong from a perfectly selfish point of view.
Why can’t we change the incentive system so that CEO’s must give back their bonuses when their fast growth policies lead to disaster a couple of years down the road.
AIG, amazingly enough, had a pretty good incentive system. Executives were awarded shares of CV Starr which holds AIG stock and they didn’t actually get vested for years. On the other hand, you could say this was really a way of Greenberg controlling executive behavior since he could nullify the shares at will. Obviously this didn’t work either. The trouble there was that no one really understood the Financial Products division except the people inside and they they were incentivized differently than the insurance executives.
anon 7:45,
Your criticisms are welcome but please be mindful of your tone, one of the reasons this blogging community is so highly valued is because it encourages both discourse and learning from everyone.
Taleb faces the same problem the Austrians do. No one takes their sensible claims seriously because doing so would require them to shatter their false preconceptions about how the world works. It’s very hard to argue with the religious dogmas of the neoclassical establishment. Faith does not brook logical dissent.
I think one important point of about using heuristics and pattern recognition for rapid decision making is that it is generally highly accurate when the patterns are well recognized due to multiple prior encounters: think of a surgeon trying to control bleeding intraoperatively, a tennis player making a particular shot, a physician making a medical dignosis, an animal tracker in the wild or a chess player. In this situation repeated prior exposure and practice makes the pattern recognition accurate. In this situation an accurate solution is rapidly identified. On the other hand if heuristics and pattern recognition are used for decision making when dealing with unusual or atypical or novel situations the solution is forced on the situation and the decision is often wrong. The current financial crises was recognized as impending by those who had the appropriate cognitive framework to apply to the US and global economic situation: the Austrian School of Economics. Unfortunately, none of them are in the Obama cabinet.
David,
Pretty nice straw man you’ve got going there, yourself,..unless you are going to start siting chapter and verse, you are just being contrary.
Speaking of large tails, did anyone see the tail on that large asteroid that missed the earth by a mere 45,000 miles last week?
Not only didn’t I see it, but I can’t find anyone who was aware of it ahead of time. Lot of good those astrophysicists are doing us.
And, from a market perspective, think of the impact that meteorite would had on the markets if it had hit earth anywhere. Reports said that it would have matched the Siberian 1,000 mile diameter destruction of the asteroid hit a century ago. And the environmental effects were felt for years afterward.
What if last week’s asteroid had hit anywhere in a populated part of our planet?
I’m betting that no economic or market model has that possibility considered.
Yves,
You nailed it:
“Essentially, Taleb paints a picture of the world and human behavior that is unflattering. So as much as his work makes a fundamentally important set of observations, its success may be largely a function of luck. It came out just when the credit markets were starting to unravel and well established practices, both among traders and the broader financial community, were being shown to have serious flaws. Had his book come out at another juncture, it probably would not have been as well received.”
Prior to 2008, Taleb was losing money for many years betting on the disaster scenario (he was long vol).
In 2008, he made bet against everyone, just like Paulson, and they both made a killing.Good for them. Does this make them geniuses? Absolutely not.
The late John Kenneth Galbraith once remarked that “in a bull market everybody is a financial genius”. In a bear market, all shorts are “financial geniuses”.
But how many hedge fund managers consistently outperform in all markets? From experience, I can tell you very, very few (except for the scam artists like Madoff and Stanford).
I do, however, like Taleb’s discussion on the “illusion of stability” (go to Charlie Rose.com and look for that interview).
Pension funds got fooled into believing that by diversifying away from government bonds into alternative investments like hedge funds, private equity, commodities, and real estate, they would make their actuarial returns and escape the vagaries of the markets.
All they did over the last six years was contribute to systemic risk by buying the products that investment banking sharks were peddling to them.
Worse still, the due diligence in many public pension funds was weak and non-existent as they all toppled over themselves to get into these alternative funds.
When the alternative investment bubble burst, after the housing and securitization bubbles burst, that’s when pension funds realized they were highly exposed.
In essence, Taleb and Paulson made money betting against big pension funds that were recklessly shoveling billions into risky assets they simply did not understand. Diversification was a chimera – it simply wasn’t there when they needed it the most.
They all found out what systemic risk is all about, but instead of investing in bonds like they did in South Korea, global pension funds are investing more into alternative investments, trying to reflate the bubble.
It’s the next big disaster that will cost taxpayers around the world billions of dollars.
Regards,
Leo Kolivakis
Pension Pulse
@Yves said…(the mildly depressed make more accurate assessments. I have often wondered which way the causality runs: do they make better assessments BECAUSE their unhappy state strips away the rose-colored filter, or are they mildly depressed because they keep giving more realistic assessments, which makes them a drag to be around, and they are depressed because they encounter social rejection?).
skippy…welcome to my world, try and be objective only to be rejected as a doom persona. Better to keep mouth and mind in silent mode and play the observer. Burn all self help books, is my dream.
…
Yves said…It has been pretty well documented in brain research that humans can only hold so many variables in their consciousness at once. Our decision-making capabilities are more limited than we’d like to believe. And confronting every situation as if it were new would be simply exhausting,
…
skippy…bullets and other means of personal destruction can expand the mind and condense time frames in most interesting ways, which at a later time can be used in reference to other mental activity’s or realities if you live.
@Steve…I concur with your statements and reference to NNT observations with regards to, “abusive use of low-dimensional models”. I myself, play around with physics models using the_Valve Engine_in it I have control over all aspects, inanimate objects and identity’s (up to 200 complex identity’s). Although a poor mans hobby I feel much can be gleaned from the experience, especially when using other works and having a play with variables. Its great to see interaction in real time and in dimensional view as compared to graphs and flat 2 dimensional renderings. My life and educational experience, brings me to the conclusion, to look far over the horizon before taking a leap and if optics will not allow this, be aware of the fact that you could be in the middle of a mine field. Then its time to get on your hands and knees and probe slowly to safety, then flag the the mine field for others consideration.
@Richard said…This got anything to do with global warming models?
skippy…yes, but the advances in data input via planetary sources Ice bubbles, mud records etc, collection in real time via sensors in orbit, on earth and sea, with improved computational power have greatly improved accuracy in orders of magnitude. Will it ever mirror real time/future conditions to the atomic level, I think not(or not for some time, atomic valves for binary with Quantum structure would be required.), we would have created time travel (forward) by remote observer, if so.
Never less I do miss Boulder Co, the conversations and friendships which could randomly ensue was refreshing, all while partaking in a nice micro brew or meal at the Sink, Walnut Brewery, West End Pub. Thank you CU, NOAA, Chamber of Commerce HQ (with all your funny things sticking out of the roof). Dam sorry every one, gone all romantic, back to mild depressive state.
My hope will stem from acceptance by the population in general, to a more pessimistic view of historical feel good belief/ology/ism systems. My hope is we use history only to show us what not to do and we go forth creating a new path out side historical adhoc system creation. Is not the synthetic derivative foolishness just a manifestation of our society via the investment system, constructing increasingly shorter time lines with regards to human interaction/outcomes (dam the punish/reward chemistry in our feeble minds), or the does the real human suffer pain to understand its creation/creator and deal with it/them or chew off the limb and escape the sensation (pain/discomfort), only to risk further episodes, all for the brief reward/perception of success in short time lines.
Skippy…Richard, if it all comes down badly. I will be glad to exchange red beans and rice recipes with you, she’s a big beautiful lady, so it must be filling.
Back again, had door knockers (belief) ones, not to worry, time will not allow information to coalesce before returning to like minded fellows, mental reward for herd behavior/I belong.
Sy Krass said…
It seems that very few realize that the “market” is in reality only a giant paramutual casino/bookmaker. Any theory regarding its behavior is an attempt at rationalizing throwing some money down on horse #2 and yelling and shouting and praying that he comes in first. Very much separate form the real world other than knowing everyday life is a “gamble.”
anon 8:48
repeated exposure to similar datum does not make pattern recognition accurate as you assert. Sometimes yes patterns are uncannily accurate, other times you can only see similar rhymes, other times the rhymes breakdown entirely. That is why at all times you must consider context. And as far as market behavior goes, that means considering not just price behavior but also the shifting market participants behavior to the most recent data inputs.
A brain surgeon I doubt would ever treat a brain tumor on a new patient as identical to the last person he operated on that had a brain tumor. Each case study is unique unto itself. While correlations exist, once you get into the meat of the next tumor you operate on, a surgeon had best be prepared to expect the unexpected, to find that the tumor he is operating on now bears little correlation to the last one he operated on.
And so too, market participants must approach each case study of market behavior as unique unto itself, while yet recognizing there may be similarities to past mkt behavior.
It is often the case that we should be aware that the market behaviors we study are often far less correlated to some cognitive bias we think exists. While examining market behavior in real time, we have to prepared for market behavior to morph and evolve in unexpected ways that are non-correlated to some pre-conceived bias or pattern recognition. Markets are more complex than anyone computer or person can ever possibly assimilate, no matter how high the degree of AI that that computer or person has been trained to read.
Swedish Lex noted:
Still have to read it myself. Will be interested in finding out to what degree it discusses and/or can be applied to governance in general, including political science, and not only economics.
This is a common misunderstanding of Black Swans, often noted by Taleb in interviews, much to the frustration of the interviewer and presumably audience. One guy asked Taleb when he thought the event would be done.
The point is, if there are very rare excursions far on the tails of distributions, they by definition arrive very infrequently. Thus, we have very little data about them, why they come, or even what they are. Thus, they are intrinsically unpredictable.
Consider a case that may be easier to understand. Suppose there are features on some distribution of interest, bumps, say, they occur 6 standard deviations away from the mean. How do you learn something about them? How are they to be predicted? If in fact they are as rare as a Gaussian model would suggest, these will occur at a rate of one per billion. Unless there are a lot of data available of this observation, it will be difficult to learn something about this subpopulation. One thing that’s clear: There’s no reason to believe the core phenomenon that governs the mean and its vicinity applies out there.
There is such a thing as Extreme Value Theory, but I’d guess it isn’t very help when there’s essentially no data to fit.
Thus, if the economic downturn is a Hugely Extraordinary event, it means it’s unreasonable to expect the experience and models applied to the normal — the mean — apply here. To draw upon another analogy, it’s reasonable to expect models of vibrations of lattices of masses connected by springs to work when perturbations of mass centers from equilibrium are small, even if spring constants vary across the lattice. Should a perturbation be large enough, elastic deformation occurs and these constants are changed. Past measurements of the lattice before large deformation may not be of much help after such a deformation.
Sy Krass…
I don’t want my previous post to be misinterpreted. I am currently reading “Fooled by Randomness” and am fascinated by it. I do think however that there are such things as intended outcomes, not everything is random.
Anon @ 9:41 wrote:
“..does the real human suffer pain to understand its creation/creator and deal with it/them or chew off the limb and escape the sensation (pain/discomfort), only to risk further episodes, all for the brief reward/perception of success in short time lines.”
Yes. Disassociation is very rewarding, but hampers understanding. I agree, but some well paying jobs require this compromise from us.
Does true randomness really exist ?
Markets are chaotic systems.However, contrary to popular belief these are not ruled by random chance but are deterministic (i.e they are ruled by cause and effect). What makes them unpredictable is that small changes to inputs into the system can lead to huge differences in outcomes.
As for Black Swans they were well known to Australian aboriginals just not to Euopean colonists. The problem there was simply a lack of data not the supposed randomness of the universe.
Yves,
Glad you finally got to Taleb. BTW, the real Taleb is the one with the “Ciao.”
It was interesting to read these comments. I get the feeling that most commenters haven’t actually read his books.
Epistemology is probably the most important science for economists and investors. They frequently go down the wrong path and then have no idea why their conclusions didn’t work out. They are lucky to be riding a wave that happens to coincide with their strategy; and when it turns, they go down with it. Otherwise Peloton, Bear, Lehman, and the others would still be around.
Taleb sheds some light on why this is the case. Most investors used a false premise and assumed they could predict the future.
I would agree however with those that say investors knew of the risk and proceeded anyway. A paper put out by the Fed (St. Louis) by Yuliya Demyanyk reveals that during the later stages of the credit bubble, the issuers of subprime paper actually were aware of the increased risk, but thought the market wouldn’t crash, or if the market declined, their instruments wouldn’t be affected.
I think his work is profound. Maybe not original, but he makes a compelling case on a topic that few people understand.
I would also point to von Hayek whose work on the problem of applying so-called scientific analysis to economics is a basically flawed concept.
Thanks for this intelligent commentary.
Nassim,
Perhaps the initial commenter was neither using nor usurping your identity but coincidentally happens to have the same initials as you.
Ciao,
Norbert Nathaniel Trilling
Save time, skip The Black Swan and read the abbreviated bumper sticker version; “Shit happens!”
All life is politics. Deception is the strongest political force on the planet. It can be modeled through observation of its effects. Past is future, black swans are everywhere, are relative, and occur daily. Some are vastly more noticeable than others. They are the consummations of deceptions (intersections of forces in the more ‘inorganic’ world). The mouse that did not see the deceptive camouflage of the snake is having a black swan event as he is swallowed alive.
But it is the big picture that is most revealing. Humanity is being externalized from its human form — shed like the skin of a snake — and being morphed by evolution into a more aggregate form. I call it the onotron. The onotron is clearly in charge. It creates the conditions for black swan events.
It is depressing only if your ego is limited to self and you are lost in the deceptive details.
i on the ball patriot
Wow, how many of these commenters actually read the books and processed them? I did think that “fooled by randomness” was an easier and more engaging read than “the black swan”, but anyone that read that should have adsorbed the differences he labored to point out about those systems that could be modeled on standard statistical basis and those that were extreme and behaved quite differently. the main point was which are you modelling? the one where random events provide amplified influence, or the one where things revert to the mean and they don’t?
for me the main point was that distinction, and how modern systems have moved toward to extreme and away from the predictable. the trick is knowing which system you’re in and applying the correct modeling. And I think that NNT would say that the thinly veiled author in the book was a part of an extreme system like him. But also that it can’t happen unless that author took advantage of the chance encounters that got her published.
I also think that finance is proably the least interesting aspect of his points. but that’s probably a post for another time.
Taleb’s book made some very important points. My criticism is that it was far too long and somewhat redundant.
Still, he should be commended.
Yves your comment- “First, it has been so widely reviewed and discussed that I had assumed the additional knowledge to be gained by reading the book itself would be marginal.”
That is scary. I would never hire someone to manage my money who assumes things fall into a preconceived pattern. So I shouldn’t buy your book if I’ve read the review???
You are obviously jealous of Taleb (welcome to the club). Maybe he dissed you (again, welcome to the club.
But in a strange way you’ve in fact verified Taleb’s thesis by stating –
“Had his book come out at another juncture, it probably would not have been as well received.”-
So chance played a major role in the Black Swan’s success!
If there is one book people should read before commenting on, that book is The Black Swan.
The popular misconception, probably spread by CNBC, is that the book is about the current economic crisis. It is not. There are a few pages that refer to banking, but it is really about the fact that outlier events happen more frequently than we think – in all areas of life. Taleb probably spends more time on the civil war in Lebanon than on the financial world.
And Taleb does not think the current crisis itself is a Black Swan, but he does think that one of its causes was excessive risk-taking by bankers who did not properly understand risk.
Being a total layperson in the subject I thought it was very interesting and it made me look at the world in a different way.
Peersonally I think that there is crime and greed afoot and calling it a Black Swan event just provides cover for the guilty.
Yves,
Your comment about depressives is right on the mark IMO. The problem is that you are putting the cart before the horse with some of us depressives. Some of us ( I think skippy might agree) have chosen to live lives with the rose colored tint turned off permanently.
Yes, it is very depressing. Mankind not living up to its potential is an understatement.
Anon of 11:44 PM,
You make a few curious assumptions here.
I am not jealous of Taleb, I don’t do what he does nor would I aspire to do what he does. I think it is admirable that he likes to pursue philosophy and the life of the mind, but I am not wired that way.
The sort of success that gets me angry (angry, not jealous) is when people cheat, particularly when their cheating does damage to others. People like the Tanned One make me furious.
The reason I did not read his book is that I basically don’t have time to read books any more. My day job plus blogging has eaten up all discretionary time for the last two plus years. So my not having read his book was not specific to him.
I am also a little puzzled at your reaction to assessing books via reviews. THAT IS THE WHOLE POINT OF WRITING A BOOK REVIEW, to tell someone about a book and give them as sense of whether it is worth reading or not. I have also reviewed a lot of books (I have to check, but I am pretty sure more than 30), so I may have a bias that a good book review can extract most of the value of a book.
Even worse, there are services that do 8 page summaries of important books for busy business types. They assert (and I suspect that this is true) that readers retain more of the main messages from a book via the summarized version than from reading the whole thing (of course, that presupposes that the summary represented the book accurately).
And I am not a money manager.
Also, re my response to the NNT post (the first one). The reason I thought it might be the real NNT is it came in immediately after the post went up. I figured he had a bot that trolled for new mentions of his book (and I suspect that is why he showed up later, if it was the real NNT and not another poseur having fun).
Thanks to Yves and those making comments tonight very interesting discussion.
I am a prophet, and, as such, find your timing to be uncanny. For we are mere days from a negative black swan event. Two weeks out, tops. That’s the good news.
The bad news is that it will be the first in the cluster.
This posting is convincing me to try reading NNT again. His efforts to help us re-adjust our understanding of predictabilty bring to mind Hannah Arendt’s claim from decades back:
“Every act, seen from the perspective not of the agent but of the process in whose framework it occurs and whose automism it interrupts, is a “miracle” – that is, something which could not be expected. If it is true that action and beginning are essentially the same, it follows that the capacity for performing miracles must likewise be within the range of human faculties. This sounds stranger than it actually is. It is in the very nature of every new beginning that it breaks into the world as an “infinite improbability,” and yet it is precisely this infinitely improbable which actually constitutes the very nature of everything we call real.”
Arendt, On Freedom, 459.
As Taleb pointed out, it is not the known risks that are most important to hedge against, but the unknown risks
–A practitioner cannot use his information, it is navel-gazing. Can I change a multi-billion dollar asset allocation because of a 1/250 chance tail end of something happening?
NNT, who is your editor for your books? I find your books theoretically interesting but rife with artifacts and meandering comments that I would expect an editor to correct.
Economics is not and never has been a true science. It doesn’t use the scientific method. There is no observation, postulate a theorem, then conduct experiments in attempts to falsify your theorem.
Instead, economics is more like a philosophical circle jerk, with each economist trying to prove that his circular argument is better than the next guy’s circular argument.
Note that this does not mean that we might not develop a much more real science of economics, instead of the quackery that we get today, but so far this has not occurred. So we get the Talebs of the world who get rejected, not from empirical data, as in other real sciences, but just because someone doesn’t like that idea.
The longer term solution, and it might take a very long time, is to begin developing a real science of economics. And in the short term, we need to recognize that the so-called economic experts are the ones that got us into this mess. In medicine, architecture, engineering, or other fields, results this bad would get your license revoked and lawsuits against your performance. It’s a pity we can’t do the same to the modern era’s version of court astrologers, aka economists.
Yves, (and to ekzept),
Thanks.
So, the book is of general application and would imply that it is beyond society’s grasp to foresee, and prepare for, very random events that can have significant consequences when they occur.
The economic crisis was foreseeable. It started during the build-up phase, really, at least a couple of decades ago. The signals of the looming crisis were however largely ignored by both economic operators and by government, with the former adapting and seeking to profit from it.
Man-made global warming has been going on for far much longer and was probably not detectable for a long period. Future generations will pay the price of past ignorance and the current failure to reverse the course sufficiently. Thus, again, a problem of governance since once we discovered the existence of global warming and it consequences, society was quite inefficient in adopting new and better policies.
Humanity’s impact on the environment will continue to increase exponentially. We are probably not aware of the future impact of today’s technologies. One example of society actually trying to respond upstream is the EU’s REACH legislation that forces producers of chemicals to demonstrate the level of hazard that their products possess, ahead of putting them on the market. A colossal amount of data about the impact of chemicals is being created, costing Industry and arm and a leg. This legislation was introduced with the global chemicals industry fiercely lobbying against in Brussels. The U.S. Industry wanted a trade war with the EU over this issue. We do not know if the REACH legislation will be successful, but it is an attempt to steer the design of new chemical products towards sustainability, i.e. pre-empting future environmental crises through improved governance.
Through improved governance, it is in my view possible to address unknown unknowns earlier and more efficiently although they, per definition, cannot be avoided; “shit happens”.
Yves on these pages a couple of days ago wrote about how boring it is with stakeholders that first and foremost defend their ideologies, even after the facts have changed. I started out as a neo-liberal (a reaction to the expansionist Swedish socialists at the time) but had to reconsider everything when the Swedish nanny state, that I had learnt to oppose so much, had to step in and save the financial system.
Since then, it has become clear that it is not a question about big or small government, really. It is all about good and bad governance. We are currently using a model for governance that was invented by the Greeks. It is time for democracy 2.0.
Jefferson said that each generation should throw out the constitution of the preceding generation and start over. Instead, however, the U.S. Constitution has been turned into a secular religion that cannot be questioned or touched. I would vote for Jefferson. It is time to review the fundamental mechanics of how society is working. If not, it will be crisis management from here on, whether it is the environment or AIG.
Many of you commenting on these pages are 1) appalled by the crisis and the corruption it involves and 2) very sceptical as regards society’s capacity to adapt and improve over time. I share those views but would like to add that suggestions on improvements, however futile they may seem, are necessary. Yves, what I am really thinking of here, I guess, is that I hope that your book will be forward looking too, with your views as to what needs to be done. The tentative title of your book suggests that you possibly will be writing for the prosecution only. I hope not.
@ sammy said,
You missed the whole point of the “highly improbable.”
It matters not what your asset allocation is. What matters is how you hedge against the risk of the highly improbable. Events that are considered highly improbable are a risk management consideration, and not at all an asset allocation matter.
In my experience, traditional asset managers only consider asset allocation matters. Everything is framed as being an asset allocation decision. No it is not. Asset managers that operate solely in this framework and mindset simply understand next to nothing about the vast array of risk management tools outside the asset allocations models taught in finance classes.
@anon12:17…Some of us ( I think skippy might agree) have chosen to live lives with the rose colored tint turned off permanently.
…
Yes I choose to live with the pain, not disassociate out of emotional convenience, maybe a bit for the wife and kids.
Skippy
The following three books and authors were pioneers in studying human “hedging” through millennium:
The Golden Bough: A Study in Magic and Religion is a wide-ranging, comparative study of mythology and religion, written by Scottish anthropologist Sir James George Frazer (1854–1941).
and,
The Hero with a Thousand Faces (first published in 1949) is a non-fiction book, and seminal work of comparative mythology by Joseph Campbell. In this publication, Campbell discusses his theory of the journey of the archetypal hero found in world mythologies.
and,
Grimm’s Fairy Tales (pub. 1812) W. H. Auden praised it, during World War II, as one of the founding works of Western culture
Click “brushes9” for wiki link to Grimm’s Tales.
Excerpt from Frazer’s, “The Golden Bough:” Mentor Book, ed., 1959.
From the authors introduction, Cambridge
18th September 1900
“the comparative study of beliefs and institutions of mankind is fitted to be much more than a means of satisfying an enlightened curiosity and of furnishing materials for the researches of the learned. Well handled, it may become a powerful instrument to expedite progress if it lays bare certain weak spots in the foundations of which modern society is built–if it shows that much which we are wont to regard as solid rests on the sands of superstition rather than on the rock of nature. It is indeed a melancholy and in some respects thankless task to strike at the foundations of beliefs in which, as in a strong tower, the hopes and aspirations of humanity through long ages have sought a refuge from the storm and stress of life..at present we are only dragging up the guns into position..the task of building up into fairer and more enduring forms the old structures so rudely shattered is reserved for other hands, perhaps for other and happier ages.”
RIP, Frazer.
Click “brushes9” for google’s “full view” edition.
“Since then, it has become clear that it is not a question about big or small government, really. It is all about good and bad governance..”
Actually it is. USA with 435 Congress member has one representative per 700 000+ people. Nordics got about one per 20000-40000. Most Western countries have something in between.
The more people you got per representative, the bigger the election campaign costs are. The bigger the costs are the more plutocratic (the rule of the rich) the society will be, effectively shutting out the majority of people, just like in the case of USA.
USA started with one representative per 30000 people and with about four million people. Now to go back to that original ratio with 300+ million people, there would be TEN THOUSAND CONGRESS members!
The upper limit for functioning democratic society is actually quite low, about 300 times 50000 = 15 million. One representative per 50000 people and the campaign costs would still be within the reach of middle class candidates. This means Australia is at that upper limit or close to it. All bigger nations are more and more plutocratic.
You can already ses that NNT’s ideas have no chance of becoming main stream. Despite his profile being raised significantly the media, as they often do, try to condense a complex idea into an edible sound bite for the bloated masses who don’t/can’t read.
In every interview I’ve seen, the interviewer bascially ends up asking NNT for a prediction of the next Black Swan. Ironicaly they don’t seem to get that one of NNT’s main thesis is that black swan’s be their very nature can’t be predicted.
“Of course, one reason is that the implications are pretty uncomfortable for a lot of professions (although Taleb would dispute their clams of professionalism).”
If Economics failed us, then all other American “professions” (High Class Labor Unions) are called into question. A “profession” is anything you can get Corrupt Politicians to certify as such.
Most Universities that generate the Paper which qualifies for entry into these High Class Labor Unions are heavily susidized by Government and Corrupt Corporations.
I would love to hear Taleb on the so-called Science which has been done to claim the Hadron Collider and many other scientific projects are safe, will cause no side effects and are “good to go”. After all, they did Risk Analysis on that just like the Wall Street crooks did on their fraudulent, toxic insecurities. Scientists are humans just like the rest of us. And as such, they have a vested, career interest in seeing their pet projects funded and financed just like the Wall Street Professions. To any observer, that would automatically skew any analysis by them.
Taleb in one interview says to paraphrase: Negative information is more valuable than positive information. Well, that is why his ideas will not be listened to and implemented. And, if that is true, then we are doomed. because we are playing with increasingly dangerous technologies. This financial collapse will look like a picnic compared to what is to come.
One of the things I’m struck by is the number of people who get Talebs point all wrong.
He does not say that this crisis or any others are Black Swans, simply that our current modeling techniques say they are. His point is that they are much more common than our gurus maintain and that is why our gurus should be drawn and quartered. They are ignoring information that is right in front of them. How is it that 4 sigma events can keep happening every 20 yrs or so?
His investment philosophy is very simple, keep 80-90% very safe and use the other 10- 20% to invest in very risky out of the money options.
I can only say that I learned the randomness and chaotic nature of things long ago in a far away jungle. I’m sure Combat Command had their plans on what would unfold and how they would react. Unfortunately when a bunch of pajama clad people didn’t exactly do as planned by the learned wizards all hell broke loose and chaos ensued. We learned after a while to take what TPTB told us and just shrug and adapted to what was going on around us
Did anyone really think the first NNT was really Taleb?
If that first NNT really had been Taleb, think of what it would have meant:
1. That Taleb really is an insufferable meglomaniac who has his computer rigged to blare an alarm any time someone mentions his name, so he can act with the alacrity of an NYFD First Responder?
OR
2. That Taleb was just idly perusing the Naked Cap Archives, when…BAM…a post about Taleb just happens to flash before his eyes….Holy Cow!
Why wasn’t this issue being discussed prior to the real Taleb clearing the matter up? Now that would have been an interesting discussion.
Instead, all we got were questions about global warming and “non-statistical processes”.
Too damn funny…..
Two points: Firstly, it seems to me that some people have misunderstood Taleb’s Black Swan investment strategy, as described in the Malcolm Gladwell article “Blowing up”. Briefly, Taleb is not a “short” like John Paulson or David Einhorn, who make money predicting specific crashes (such as the subprime debacle).
Rather, his reasoning is that, if “tail risk/black swan risk” is chronically undervalued by market participants, investing in out-of-the-money-options, sight unseen, is a (very) long-term (but you can’t predict how long) winner. The distinction is critical.
Secondly, as NNT himself keeps repeating (to apparently deaf ears), the Black Swan itself is a problem of perception first and foremost. If you saw the subprime collapse coming, congratulations – it was not a Black Swan – to you. It was still a Black Swan to Bear Stearns and Lehman.
I have yet to read the book but the MSM I and many comments here) seem to be characterizing the current meltdown as a “black swan event”.The current crisis has nothing to do with randomness and everything to do with causation.
The mortgage underwriting and securitization process was corrupted leading to a very predictable outcome.
The CDS business was corrupted, leading to a very predicaable outcome.
It only seems random when compared to the distribution of returns experienced during the long period of successful, bank owned mortgage market.
Using multivariate analysis, which is based on the normal distribution, I inferred the stock market valuation was wildly skewed toward future growth as opposed to current cash flow and exited a couple of years ago. It was difficult not to drink the kool-aid and fudge my analysis like so many of us have.
Good luck to all. This is not over by a long shot because we continue to “bullshit” ourselves into thinking there is a free lunch to be had by trying to support collapsing asset prices and bailing out worthless CDS contracts.
I got a lot out of both
‘Fooled by Randomness’, and ‘The Black Swan’, but I thought Taleb was dead wrong in his criticism of ‘The Millionaire Next Door’ in FBR. He says that the millionaires in the book got that way because of a chance circumstance: they happened to live at a time of rising stock markets. If you read ‘Millionaire Next Door’, you would conclude that the Millionaire’s got that way because they were reluctant to spend money. Taleb’s observation here always confused me.
Sure enough, right after I post somebody comes along and demonstrates my point.
“The current crisis has nothing to do with randomness and everything to do with causation.”
We are not talking about roulette-table-college-statistics-introductory-course type of randomness here; TBS is a question of opacity. Opacity being an inevitable characteristic of complex systems.The fact that some people spotted this particular clusterfuck coming is completely beside the point.
Taleb’s book is not merely about finance, or about making predictions… it’s about the intersection of psychology and epistemology, about how we think we know what we supposedly know.
The practical applications for his epistemological principles are legion, and they include the current economic mess, but they are certainly not limited to that specific example. They help define what it means to be human (both our strengths and our cognitive weaknesses) about as well as any philosopher has ever managed to do.
Taleb has a wonderful presentation at fora.tv, of a talk he gave to the Long Now Foundation, and for all those who haven’t read one of his books, consider instead spending an hour and a half listening to him speak and answer questions.
It’s well worth your time.
Some of us are just amazed how much money that Taleb can make from suckers by retreading the ideas of Karl Popper (the orginator of the concept of the Black Swan), Benoit Mandelbrot and others. In view of his lack of originality one might think a little humility would be in order. Unfortunately, he just comes over as an arrogant know all. If he hectored his audience less and stopped talking to them as though they were intellectual pygmies then I might have more time for him.
Yv,
What you have are bankers who are willing to leverage their bets, collecting bonuses along the way for a long time, with money that is not their own, based on risk-models based on data that only goes back fifteen years, and when they blow up, because they are leveraged 20 times, 60 times, 100 times! we all blow up.
NNT..:)
(but, I didn’t make earlier post under NNT, I just know how he talks)
Click “brushes9” for that ForaTV , Taleb presentation link!
Dashiell Hammett covered this idea better with his ‘FlitCraft Parable’ of the Falling Beam in the Maltese Falcon (a much better read than Taleb).
http://www.fallingbeam.org/beam.htm
Of course, like the fortuitous protagonist of the story once the beams stop falling we may eventually just return to behaving as though it had never happened.
Once again, I would offer thanks to Yves for mainting this blog and appreciation for all the intelligent, informed comments.
The most astonishing thing, I think, about Taleb et. al. is that their way of thinking is so clearly true — on an intuitive level — from direct observation of financial markets over history.
And that this truth was ignored willfully, in my view, by a generation of finance departments, Wall Street firms, politicians, regulators and any and all forms of authority — in a mad Gold Rush for self-enrichment at what was transparently clear to be an eventual massive price to society as a whole.
The lack of integrity is, itself, unsurprising, given human history.
But the absence of any possible remdiation by the agency of political separation of powers and regulatory oversight is nothing short of astonishing.
We think we are above the group think that cause the Gulag, KKK, Nazism and the other diseases of tribal consiousness that make history so “interesting.”
We think we are above all that. The refined and civilized prodigy of our higher education institutions. The gift of centuries to the perfection of the human condition. ha ha haaahhhahah haha hhahah !!!!!!
The TNT for NNT. ha h ahhhahaha!
But a look in the mirror says otherwise. The abandonment of integrity, honesty, transparency, principle, self-reflection, etc. in all facets of contemporary money and finance is yet another chapter in the sorry history of group think and hive consciousness.
Someone mentioned Joseph Cambell and James Frazer. We could also give a nod to Gustav LeBon and Freud and Charles McKay as the popularizers. These are the intellectual heart of the matter. The math is the surface.
This is an interesting discussion, but rather odd in some ways. Particularly because the question of the policy implications of Taleb’s theories seems to be being treated negatively rather than positively. I mean: IF some key events are inherently not predictable, and once they occur the path back to “normality” (generally predictable, close to equilibrium conditions) is also not predictable, THEN what measures do we take to minimize the risk attached to such events. This is a question of risk and costs.
An issue in climate change theory with similar unpredictable features is the breakdown of the North Atlantic Circulation (Gulf Stream). Here the necessary response is not to say, well, we can’t really predict when or whether it will happen. Rather we need to attach an upper limit of probability to the event and a lower limit of cost. Then we can talk about policy response.
Similar considerations would have applied to economic issues discussed in this blog, such as the global imbalances of the last few years and their consequences. Too late now, of course, but for the future?
Taleb’s book is more or less better (much more readable) presentation of Mandelbrot’s. That said, that in itself makes is an important book, as sometimes new idea needs not just a propeth, but an evangelist.
I still have a lot of problems with Black Swan and Taleb’s thinking (for example, he seems to disregard the importance of the “background” to his black swans, concentrating on BS – but without a lake, swan is just an overgrown chicken, and a black swan event’s impact depend a lot on the current “background” – state of society).
Yves, you touch a very important subject here though. That is, the inbred optimism of the human race. For humans, it’s a survival trait. If humans weren’t optimists, they would give up living – hope is eternal, it let’s us go on. Unfortunately, at the same time, it’s the greatest downfall, as it doesn’t let us see the reality as it is (Terry Pratchett describes it best – if humans really saw the world as it is, they would go mad), and does lead us astray (not can, it does)
So far, we have been lucky – or maybe just not unlucky yet. This will change. The changes aren’t just things like the current financial crisis – the only way that could destroy humans as such is to lead to nuclear war. There’s tons of events which would wipe us, and in fact will wipe us – Yellowstone is a huge caldera just waiting to explode, somewhere out there is an asteoroid on a collision course etc.. But we black it out, and go on living.
“if humans really saw the world as it is, they would go mad), and does lead us astray (not can, it does)”
…astray of the herd,..makes others fearful..they attack, you get mad.
(Click “brushes9” for wiki link on Pratchett,..thx v.
There seem to be a clutch of people who see more clearly into human condition like Mandebrot and Taleb, Art DeVaney, psychologist Wolfgang Giegerich and soil scientist Elaine Ingham, Allan Savory. All are given lip service in their fields, are close to the heart of change going on now and always marginalized. The ideas and images that are carried by these people and those of us who follow them have huge vitality that convention cannot tolerate.
penchant for heresy
To really put a twist on this thread, consider what Eastern thought offers. It would say that because our minds are of the same fabric as reality, any order that we impose leads, necessarily, to suffering, because our models of self-hood hedge risk poorly, overestimate the value of our growth strategies, ignore contrary indicators, invest too much, etc.
BUT, living the “enlightened” life that this analysis suggest has, historically, only been possible as long as the merchant-villagers feed you through their donations, keeping you alive.
Eckhart Tolle is currently making millions on the arbitrage between Western and Eastern analytic traditions, but nowhere in his book, “The Power of Now,” does he detail how living “in the now” may require regular food donations to your house from your neighbors!
It is nonsense! If you follow Eckhart Tolle, you blow up!
No, seriously, I believe that immersing yourself in Eastern thought is a good thing, but like Jack Kornfield says, “after ecstasy, the laundry.”
Click “brushes9” for what is Jack Kornfield’s best book, “A Path With A Heart.”
I have already commented on why Prof. Taleb’s black swan critique of risk models is superficial, rather, the concern should focus on the efficient market hypothesis (EMH) as an underlying theory of financial models, go to the link below for more information:
http://www.theastuteinvestor.citymax.com/page/page/1425688.htm
However, financial risk modeling has an interesting almost haphazard history which further complicates bank “stress testing” ongoing today. Harry Markowitz, the father of modern portfolio theory, for which he received a Nobel Prize in Economics in 1990, in his 1952 paper in The Journal of Finance assumed market efficiency, because his entire theory relied on stock prices being random variables, and a normal distribution to model stock returns because mean and variance would then be the only two measures that investors need consider. Mean, is desirable, and equated to “expected return” and variance of return, is undesirable, and assumed to adequately model “ risky-ness of the investment.” Markowitz never explained why variance/standard deviation measures of price volatility should be a good proxy for the “risk of loss,” although academe readily accepted it.
Warren Buffett criticized using volatility measures for risk measurements because that precludes knowing anything about the company’s intrinsic value. A company’s stock which is highly volatile would be considered mean-variance risky, however, if that same company had a very high intrinsic value and the stock price dropped to the low of its range, Buffett would then rightly consider the company to be a buy and a relatively risk-less purchase. Buffett’s explanation is logical while Markowitz has a mathematical solution in search of a problem, or as Yves Smith would say, “computational convenience trumped empirical findings.”
Eric L. Prentis is the author of The Astute Investor and The Astute Speculator.
An intersting exploration of the concept of depressive realism can be found in the following:
— http://www.runet.edu/~jaspelme/_private/gradsoc_articles/Depressive%20Realism/Are_the_sadder_wiser.pdf —
Szilard_Daemon
Yves,
Great post. As someone whose job is to develop scenarios on global and regional challenges, I happen to share many of Taleb’s views. It would be very interesting to see how society might be different if we all had a rich understanding of the role that uncertainty plays in life. My own incentives and biases are lined up to say it would be better, but that’s a viewpoint that is very hard to empirically test!
A couple of quick points:
First, to the issue of whether the set of Taleb/Mandelbrot(etc etc) ideas could spread in a useful form (rather than as a misunderstood cliché). As you point out, a single book or person are unlikely to effect a major change in outlook on their own – for that, a movement is required. And, as you say, any movement has to overcome a range of challenges in the form of explicit incentives, psychological discomfort and cognitive biases. I know that Taleb is doing all he can to spread the concept through interviews etc, but in the end the change has to come from those who influence behaviour through their positions in society. In this case, (as NNT himself pointed out) the relevant people are CEOs, policymakers and those responsible for business school education.
Leaving aside how you go about this for a second, it is possible that if (amplified by the timing of the book) a few key people/organizations internalize the concepts in fooled by randomness and TBS, AND IF their new outlook/approach positively affects organizational performance, AND IF this link is recognized – the resulting success of practices based on TBS could cause the idea itself to prosper and spread. That’s a lot of ifs, but something we spend a lot of time thinking about in relation to scenarios, which (at least in our approach) have a lot in common with FBR/TBS concepts. I’d love your thoughts on this.
The other major issue is, of course, whether TBS concepts can lead to a practical decision-making framework that can go some way to solving for cognitive bias and the uncertainty inherent in complex systems at one fell swoop. For me, this is the holy grail. In my mind, there’s a need to integrate the reams of research out there on cognition, decision-making, complexity and leadership into a testable approach for facing important decisions. A tall order of course, but perhaps we’re a little bit closer thanks to the existence and timing of books like The Black Swan.
As Nassim Taleb himself has pointed out: This crisis is not a black swan. The events that led to the failure of Bear Sterns and Lehman Brothers were not outlier events but entirely predictable results of bad regulation. When you lend money to people who can’t afford to pay it back, you will lose money. This is not a black swan; it is an everyday white swan. Not six sigmas; pretty much zero sigmas.
But second, and perhaps as important, people do not want to see the world as subject to chance to the degree that Taleb says it is. This is hugely unsettling if you really do come to terms with the implications of his argument. We like to believe we have some measure of control over our lives.
Yep. As ‘the social-metabolic system’ has driven more closely to its ultimate global limits, increasing uncontrollability is almost necessarily rejected…
As a former computer scientist and currently a psychologist, I can certainly testify to human beings’ biased cognitive ability, distorted perception of reality, a hard-wired ability to lie to ourselves, a poor and fluid memory, and an astounding ability to make bad decisions. Most of us also fail to recognize just how vastly our decisions are driven by that awful limbic system in our brain, a primitive complex of specialized regions that deals with emotions, motivation, memory processing, and impulse control, among other things. Yes, Virginia, all your decisions are fundamentally emotional decisions. Our brain was not made for logic. Or, at least not the kind of logic needed to understand this seemingly non-predictive, non-causal, non-linear, non-Euclidian reality we seem to live in.
The brain is basically a survival organ, fine tuned, as the article says, for quick pattern recognition and application of rules of thumb. A very large portion of the brain is dedicated to this pattern recognition complex, and while this mechanism is computationally very impressive, it’s really useless for conceiving stable economic models. Basically we’re good at recognizing an approaching bear (or bull, if we’re lucky :) and quickly deciding whether to run or stay and fight. Fight of Flight. That’s us.
As such, it is to be expected that most models we have of reality (or financial models) are likely flawed. While Mandelbrot’s fractal geometry seems to unlock a few more doors, we’re a long way off still.
I’ll end now, as my next patient is coming in – a schizophrenic whose reality I just can’t wait to find out more about…LOL
Vinny Goldberg
One more thing. The reason some people are more successful than others in this world is because they instinctively understand that emotional limbic system part of the brain I mentioned above. That primitive motor of our intellect. They understand fear, greed, hope. That’s how people like Madoff achieved their success. That’s how Bush got this nation into a war that enriched his friends. That’s how cults become so successful. It isn’t logic or beautiful mathematical models that win the day – it’s emotion everytime.
That is what we are up against. One more theory based on chaos or fractals won’t protect us. What will protect us is understanding how dark, limited, and dangerous our brain really is, and being aware of those that can manipulate that that darkness. I speak here as a forensic psychologist who saw more than my fair share of criminal minds and the suckers that fell for them.
Vinny Goldberg
«The more people you got per representative, the bigger the election campaign costs are. The bigger the costs are the more plutocratic (the rule of the rich) the society will be,»
Very interesting and very plausible point.
yves — if you’re interested in the causal relationship between pessimism and accuracy, this recent bit in the economist is informative of the state of the science. turns out that at least some kinds of optimism result from a genetic predisposition to distort reality.
Vinny,
If you can’t make your limbic system your best friend, then you are your own worst enemy, right?
Maybe you dread the next schizophrenic into your office, because you know that you haven’t resolved your own, inner conflict, except by electing a ball-crushing, punitive and ruthless father-introject as your inner-guide.
I would rather be schizophrenic that to be like you.
@Justin: I’m glad someone else noticed the connection between NNT’s and Wolfram’s New Kind of Science; cellular automata could IMHO be powerful tools in the analysis of black swans. I also wonder what NNT’s and Wolfram’s mutual opinions of each other are.