Seen any Black Swans lately?

I live in part of the world where black swans don’t seem that unusual, but for many the idea of a black swan was unthinkable until they were actually discovered in Australia. Somewhere, I even have a hat with 32 Black Swans on it. The metaphor of Black Swans just doesn’t work in part of the world where they are plentiful but it is a strong visual idea.

“Before the discovery of Australia, people in the old world were convinced that all swans were white, an unassailable belief as it seemed completely confirmed by empirical evidence…that was disproved by the discovery of black swans.”

So what is a Black Swan?

Author Nassim Nicholas Taleb has written a book to explain the central idea of a Black Swan: The Impact of the Highly Improbable.

In his description a Black Swan is typified by 3 attributes.

  1. Nothing in the past can point to its possibility
  2. Extreme Impact
  3. Even so we can somehow explain this by hindsight after the fact -( I believe this is called a confirmation bias in investment circles.)

It is an interesting idea and best of all, you don’t have to read the whole book to get the arguments – you can read a much shorter manifesto by Taleb called Few & Far Between which has been made available on www.ChangeThis.com and here as well. (16pages version) download your copy free above.

Taleb makes some good points about our blindness with respect to randomness and the ability we have to ignore large deviations or outliers – when I suspect he is more interested in the outliers.

The metaphor got me thinking about complexity theory and fractals where patterns become evident if you sweep wider enough to see them. So perhaps the patterns are always there; but our frame of reference is focused too much on the micro to see the true significance of the macro.

The idea that you can’t predict a Black Swan seems self defeating – or that in hindsight you can somehow explain the linkages. That we need to be looking much widely at impact points is a key point that is not quite made; but should be.

Larry Elliot seems to like the idea of Black Swans and markets..and knows more about maths than I do.

“Taleb is a fan of the Polish-born French mathematician Benoît Mandelbrot, who gives short shrift to those who believe financial markets resemble a bell curve, with modest movements the norm and violent moves infinitesimally rare. Looking at the daily movements of the DJIA from 1916 to 2003, Mandelbrot said that according to the bell-curve analysis, there should have been 58 days when the Dow moved more than 3.4%, when in fact there were 1,001.

Only once in every 300,000 years should there have been a day when the Dow moved by 7% or more, but it happened 48 times. “Extreme price swings are the norm in financial markets – not aberrations that can be ignored,” Mandelbrot argues in The (Mis)Behaviour of Markets

It seems highly unlikely that this has been built into market thinking. That, of course, is precisely Taleb’s point”.

For alternative view on the Black Swan book check the review by Giles Foden who wasn’t quite convinced. I particularly like this mangling of metaphors that Foden highlights below – turkeys are like swans etc…..The paragraph is so good I can see it becoming part of a stand-up routine in the next comedy festival.

It is the silence – the gap – the missing energy in the historical system, which produces the black swan. Imagine, says Taleb, the problem of turkeys: “Every single feeding will firm up the bird’s belief that it is the general rule of life to be fed every day by friendly members of the human race ‘looking out for its best interests’, as a politician will say. On the afternoon of the Wednesday before Thanksgiving, something unexpected will happen to the turkey. It will incur a revision of belief.”

Ray Poynter notes that that the book has good and bad parts and his post is one of the best on the Black Swan concept. Ray is something of an expert on advanced quant (statistics) and his excellent review is very thorough.

One of the good points he noted about the book was.

“When Taleb talks about luck and randomness he is onto something very important and under appreciated. In order to succeed you need to be good and lucky.

When we analyse the success of something or somebody, we often pay too little heed to luck and therefore too much to what they actually did. If we accept that random events play a role in success, then we should assume that, even in theory, we can’t create a model which fully measures and predicts how to be successful.”

He also points to NYTimes review and two others.

I’d be interested to know what you think of the Black Swan concept?