The Black Swan: The Impact of the Highly Improbable

The Black Swan by Nassim Nicholas Taleb

Bronwyn James - 260212705

Why are black swans impacting our lives?

“Consider that thinking is time-consuming and generally a great waste of energy, that our predecessors spent more than a hundred million years as nonthinking mammals and that in the blip in our history during which we have used our brain we have used it on subjects too peripheral to matter.” (xxii)

Many in society consider an absence of proof equivalent to a proof of absence. Prior to the discovery of Australia in the 18^th century, where black swans are common, it was widely accepted in Western culture that all swans were white. The term ‘black swan’ developed from this sudden change in common knowledge – only a single black swan was necessary to eradicate this previously unquestioned fact. In the book, Nassim Taleb defines a black swan as a highly unlikely event that is unpredictable with substantial consequences. These events are perceived post-hoc as part of the predictable sequence of history.

Taleb divides the world into two fundamentally different types of data, those from ‘Mediocristan’ and those from ‘Extremistan’. In Mediocristan, there are known limits to what any given value can be. Limits impede outliers from significantly impacting the average. Omitting an outlier doesn’t change the nature of the data. No single data point comprises a significant proportion of the total in a large sample. Mediocristan follows the Gaussian bell curve, also known as the normal distribution. The further away from the mean, the less likely an event is to occur. In Extremistan, there is no known limit to what any given value can be. A single point can comprise a huge proportion of the total. Thus, omitting one value can skew results. When theories are developed, people have a “natural tendency to look only for corroboration” (58). This confirmation bias can produce negative ramifications in our complex modern world. Taleb suggests employing a strategy of “negative empiricism”, as “knowledge does not increase from a series of confirmatory observations” (56). Only one instance contrary to a theory can invalidate it.

For the vast span of human development, Mediocristan has been the norm. Ignoring outliers had no adverse impact on an individual’s survival and success. Today, the world is changing. Extremistan is dominating more and more elements of our lives. While the 80/20 rule is widely discussed, Taleb prefers to focus on the more extreme 50/01 rule. The rule holds that one per cent of the world population controls fifty per cent of the world’s assets. With the distribution so distorted, the normal distribution no longer applies. Experts throughout the world continue to apply the bell curve to determine risk. Despite consistent failures, they slog on with precise estimates. Taleb theorizes that analysts validate their inaccurate predictions by attributing mistakes to factors beyond their control while success is always the result of their deliberate actions. From Taleb’s empirical studies on prediction, it can be concluded that people have an innate desire to be precise, even when there is no incentive for a narrow estimate. Ever the contrarian, Taleb opines, “I’d rather be broadly right than precisely wrong”.

Another element of the normal distribution is that all events are independent. When a coin is flipped, the previous outcomes have no bearing on the result. This characteristic of the Gaussian bell curve is rarely present in real life. Instead, events tend to be highly dependent, creating a cumulative advantage – or disadvantage. With several examples, Taleb illustrates “how an initial advantage follows someone through life” (217). However, black swans and chance interrupt accumulations, both positive and negative. The potential for a virtuous (or vicious) succession of events is mitigated by randomness, ensuring that “nobody is truly established” (225).

Taleb’s awareness of the prevalence of black swans leads him to comment on the vulnerability of the current financial system. Published in April 2007, Taleb assesses the weakness of the banking sector several months before the advent of the credit crisis. Globalization has increased the interconnectedness and homogeneity of the banking sector, resulting in “interlocking fragility, while reducing volatility and giving the appearance of stability” (225). This interdependence, coupled with fewer banks of larger size, “seems to have the effect of making financial crisis less likely, but when they happen they are more global in scale”, with devastating results (226).

There is a cognitive dissonance in people’s understanding of Taleb’s argument. Many agree with his position at face value yet proceed to apply a Gaussian context to events that are inherently non-normal. This seeming contradiction pervades many aspects of human life. Logic learned in the classroom remains within its academic framework, it is “domain specific” (53). Our brains do not easily transfer concepts from the abstract to practical, or vice versa. Similarly, people interpret and rationalize black swans on an individual basis, without realizing broader trends. September 11^th is not perceived as an example of an event that “stand[s] largely outside the realm of the predictable” (xxi). Instead, common wisdom has developed “precise rules for avoiding Islamic prototerrorists and tall buildings” (xxi).

A black swan can be positive or negative – and Taleb advises how to minimize the effect of negative ones while maximizing our exposure to the positive. Black swans, by their nature, are unexpected. Thus, risk is at its lowest when it is most visible, most scrutinized, and hence most expected. Invest when the circumstances are asymmetric, “where favorable consequences are much larger than unfavorable ones” (210). It is generally simpler to focus on the ramifications of an occurrence than its probability.