Media Spotlight: The Black Swan by Nassim Nicholas Taleb
Share
A sad fact of the credit crunch is that while in hindsight it seems obvious that everything would go belly up the truth is that nobody saw it coming.
And unfortunately Nassim Nicholas Taleb’s book won’t help you get any better at spotting the next apocalyptic economic meltdown.
The book gets its title from the fact that before Australia was discovered people in the West did not know there was such a thing as a black swan. They’d never seen a black one so they thought there was only the white variety.
“A single observation can invalidate a general statement derived from millenia of confirmatory sightings of millions of white swans - all you need is a single black bird,” as Taleb puts it at the beginning of the book.
So-called black swan moments can involve a differently-coloured bird, a war, a top-selling novel by an author nobody has ever heard of and most definitely an economic crash.
Taleb has experience of both war and economic downturn. He was a teenager in Lebanon when the country was plunged into civil war in 1975 and a derivatives trader at Credit Suisse First Boston in New York on October 19 1987 - Black Monday.
His main point is that as a species we are programmed to refute the improbable and random and tend to kid ourselves we know what’s coming next. We are bad at making predictions - and unfortunately this doesn’t just apply to your average taxi driver, it also applies to the professional economists and analysts investing our pensions.
He says the only people who are good at analysing where things could go wrong are chess grand masters. And, it seems, Taleb. He co-runs a hedge fund called Universa that made money out of the recent stock market crash.
He doesn’t seem to have much faith in the economists and mathematicians who populate the City and Wall Street. He contends that by rigidly sticking to mathematical models of standard deviation, brainiacs and physicists have left themselves vulnerable to black swans.
Taleb uses a wide variety of anecdotes to prove this.
One involves hedge firm Long-Term Capital Management that went bust in 1998. LTCM was set up by a number of maths wizards who were confident their models would translate into financial success. But a combination of big events sparked by a financial crisis in Russia wiped them out.
“LTCM went bust and almost took the entire financial system with it, as its exposures were massive,” he says. “Since the company’s models ruled out the possibility of large deviations it allowed itself to take monstrous amounts of risk.” Sound familiar?
Another is a study of 2,000 predictions by security analysts. This found that they predicted nothing.
“A naive forecast made by someone who takes figures from one period as predictors of the next would not be markedly worse,” he says.
The book shows that humans are rubbish at predicting the occurrence of random life-changing events. And more importantly we’re kidding ourselves if we think the application of fancy models to evaluate the probability of such events occurring will get us anywhere.
And given our trust in credit ratings agencies and mathematicians, the credit crunch has certainly been a wonderful demonstration of that.
If you enjoyed this article, sign up here to receive daily email updates from Mortgage Strategy and Follow @mortgagestrat
