Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets

by Nassim Nicholas Taleb

People in most fields outside of it do not have problems eliminating extreme values from their sample, when the difference in payoff between different outcomes is not significant, which is generally the case in education and medicine. A professor who computes the average of his students’ grades removes the highest and lowest observations, which he would call outliers, and takes the average of the remaining ones, without this being an unsound practice. A casual weather forecaster does the same with extreme temperatures—an unusual occurrence might be deemed to skew the overall result (though we will see that this may turn out to be a mistake when it comes to forecasting future properties of the ice cap). So people in finance borrow the technique and ignore infrequent events, not noticing that the effect of a rare event can bankrupt a company.