John Sequeira


Monday, October 06, 2008
The Black Swan: Living in a power-law world

Taleb's "The Black Swan" is a recently read book that describes in great detail one of the underlying phenomenom of the current credit crisis (via Gregor):

Our brains are wired for narrative, not statistical uncertainty. And so we tell ourselves simple stories to explain complex thing we don't--and, most importantly, can't--know. The truth is that we have no idea why stock markets go up or down on any given day, and whatever reason we give is sure to be grossly simplified, if not flat out wrong.

Nassim Nicholas Taleb first made this argument in Fooled by Randomness, an engaging look at the history and reasons for our predilection for self-deception when it comes to statistics. Now, in The Black Swan: the Impact of the Highly Improbable, he focuses on that most dismal of sciences, predicting the future. Forecasting is not just at the heart of Wall Street, but it’s something each of us does every time we make an insurance payment or strap on a seat belt.

The problem, Nassim explains, is that we place too much weight on the odds that past events will repeat (diligently trying to follow the path of the "millionaire next door," when unrepeatable chance is a better explanation). Instead, the really important events are rare and unpredictable. He calls them Black Swans, which is a reference to a 17th century philosophical thought experiment. In Europe all anyone had ever seen were white swans; indeed, "all swans are white" had long been used as the standard example of a scientific truth. So what was the chance of seeing a black one? Impossible to calculate, or at least they were until 1697, when explorers found Cygnus atratus in Australia.

(from the amazon page)

I believe we learned everything we needed to prepare for the current crisis with the Long Term Capital Mgmt failure (risk model failure during market-wide sell-off; fund too big to fail thanks to positions in complicated unregulated derivates, failing; govt bailout) which the book discusses at length. And we have addressed none of the risks behind network failures in the intervening years, as interconnections have grown.

Here's hoping that the fix (and I don't mean the bailout) addresses systemic issues this time around and we don't just bury our head in the sand like we did last time, pretending to deal/regulate 1st order relationships while ignoring 2nd order+ effects of the financial web.

Update 1:

  • a better quote from the actual book...
    "Globalization creates interlocking fragility, while reducing volatility and giving the appearance of stability. In other words it creates devastating Black Swans. We have never lived before under the threat of a global collapse. Financial Institutions have been merging into a smaller number of very large banks. Almost all banks are interrelated. So the financial ecology is swelling into gigantic, incestuous, bureaucratic banks – when one fails, they all fall. The increased concentration among banks seems to have the effect of making financial crisis less likely, but when they happen they are more global in scale and hit us very hard. We have moved from a diversified ecology of small banks, with varied lending policies, to a more homogeneous framework of firms that all resemble one another. True, we now have fewer failures, but when they occur ….I shiver at the thought."

    — Nassim Taleb, The Black Swan (2006)

  • A pretty geeky article summarizing the book by the author

  • A funny-in-hindsight Forbes article from 7/2007 questioning the premise of the book:

    Q:Is A Black Swan In The Way Of The 14,000 Dow?
    A: Yes. Yes it is.

    9:09:00 AM      comment []  trackback []
  • Loving Google Desktop

    I really love the quicksearch function in the latest google desktop:

    "The fastest way to search the web, and your own computer, is to use the Quick Search Box in the center of your desktop (simply press the "Ctrl" button twice to call up the search box, and press "Ctrl" twice again to hide it). Just type a few letters or words into the search box and your top results pop up instantly. You can also use it to launch applications without having to surf the Start menu; for example, you can launch Microsoft Word by typing "wor" into the Quick Search Box and selecting "Microsoft Word" in the list of results that appears. Or, simply type in your search term and press "Enter" to search the web."

    I realize app-launchers is not a new thing, but I stay away from utilities like that because I switch desktops too often : it's annoying to rely too much on any customizations or desktop tweaks and few stand the test of time. Google desktop's search-web+gmail+desktop at the same time is too damn useful, but letting my launch apps speeds things up a lot.

  • [WindowsKey][WindowsKey]"CPAN" -- install new perl module using Strawberry perl cpan shell
  • [WindowsKey][WindowsKey]"Quicken" -- enter check from client etc.
    8:49:50 AM      comment []  trackback []

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