Skin in the Game: Hidden Asymmetries in Daily Life

by Nassim Nicholas Taleb

It is impossible for anyone to write a perfectly rationally argued document without a segment that, out of context, can be transformed by some dishonest copywriter to appear totally absurd and lend itself to sensationalization, so politicians, charlatans, and, more disturbingly, journalists hunt for these segments.

It is immoral to be in opposition to the market system and not live (somewhere in Vermont or Northwestern Afghanistan) in a hut or cave isolated from it. But there is worse: It is much more immoral to claim virtue without fully living with its direct consequences.

The investor Charlie Munger once said: “Look it. Would you rather be the world’s greatest lover, but have everyone think you’re the world’s worst lover? Or would you rather be the world’s worst lover but have everyone think you’re the world’s greatest lover?”

Courage (risk taking) is the highest virtue. We need entrepreneurs.

I speculate that had IYIs and their friends not gotten involved, problems such as the Israeli-Palestinian one would have been solved, sort of—and both parties, especially the Palestinians, would have been better off.

People on the ground, those with skin in the game, are not too interested in geopolitics or grand abstract principles, but rather in having bread on the table, beer (or, for some, nonalcoholic fermented beverages such as yoghurt drinks) in the refrigerator, and good weather at outdoor family picnics. Also they don’t want to be humiliated in their human contact with others.

For imagine the absurdity of Arab states prodding the Palestinians to fight for their principles while their potentates are sitting in carpeted alcohol-free palaces (with well-stocked refrigerators full of nonalcoholic fermented beverages such as yoghurt) while the recipients of their advice live in refugee camps. Had the Palestinians settled in 1947, they would have been better off. But the idea was to throw the Jews and neo-crusaders in the Mediterranean; Arab rhetoric came from Arab parties who were hundreds, thousands of miles away arguing for “principles” when Palestinians were displaced, living in tents. Then came the war of 1948. Had Palestinians settled then, things would have worked out. But, no, there were “principles.” But then came the war of 1967. Now they feel they would be lucky if they recovered the territory lost in 1967.

If you want peace, make people trade, as they have done for millennia. They will be eventually forced to work something out. We are largely collaborative—except when institutions get in the way. I surmise that if we put those “people wanting to help” in the State Department on paid vacation to do ceramics, pottery, or whatever low-testosterone people do when they take a sabbatical, it would be great for peace. Further, these people tend to see everything as geopolitics, as if the world was polarized into two big players, not a collection of peop...

My lifetime motto is that mathematicians think in (well, precisely defined and mapped) objects and relations, jurists and legal thinkers in constructs, logicians in maximally abstract operators, and … fools in words.

The problem with the European Union is that naive bureaucrats (those fellows who can’t find a coconut on Coconut island) are fooled by the label. They treat Salafism, say, as just a religion—with its houses of “worship”—when in fact it is just an intolerant political system, which promotes (or allows) violence and rejects the institutions of the West—those very institutions that allow them to operate. We saw with the minority rule that the intolerant will run over the tolerant; cancer must be stopped before it becomes metastatic.

After Pope John Paul II was shot in 1981, he was rushed to the emergency room of the Agostino Gemelli University Polyclinic, where he met a collection of some of the most skilled doctors—modern doctors—Italy could produce,

At no point during the emergency period did the drivers of the ambulance consider taking John Paul the Second to a chapel for a prayer, or some equivalent form of intercession with the Lord, to give the sacred first right of refusal for the treatment.

seems to see a conflict with such inversion of the logical sequence. In fact the opposite course of action would have been considered madness. It would be in opposition to the tenets of the Catholic church, as it would be considered voluntary death, which is banned.

So we define atheism or secularism in deeds, by the distance between one’s actions and those of a nonatheistic person for an equivalent situation, not his beliefs and other decorative and symbolic matters—which, we will show in the next chapter, do not count. Let us take stock here. There are people who are atheists in actions, religious in words (most Orthodox and Catholic Christians) and others who are religious in actions, religious in words (Salafi Islamists and suicide bombers) but I know of nobody who is atheist in both actions and words, completely devoid of rituals, respect for the dead, and superstitions (say a belief in economics, or in the miraculous powers of the mighty state and its institutions).

My friend Rory Sutherland claims that the real function of swimming pools is to allow the middle class to sit around in bathing suits without looking ridiculous.

So when we look at religion, and, to some extent, ancestral superstitions, we should consider what purpose they serve, rather than focusing on the notion of “belief,”

In science, belief is literal belief; it is right or wrong, never metaphorical. In real life, belief is an instrument to do things, not the end product.

We will see in the next chapter that, unless one has an overblown and very unrealistic (Greek column–style) representation of some tail risks, one cannot survive—all it takes is a single event to cause an irreversible exit from the Social Security system.

Simon formulated the notion now known as bounded rationality: we cannot possibly measure and assess everything as if we were a computer; we therefore produce, under evolutionary pressures, some shortcuts and distortions. Our knowledge of the world is fundamentally incomplete, so we need to avoid getting into unanticipated trouble. And even if our knowledge of the world were complete, it would still be computationally near-impossible to produce a precise, unbiased understanding of reality.

As for Ken Binmore, he showed that the concept casually dubbed “rational” is ill-defined, in fact so ill-defined that many uses of the term are just gibberish. There is nothing particularly irrational in beliefs per se (given that they can be shortcuts and instrumental to something else): to him everything lies in the notion of “revealed preferences.”

Judging people by their beliefs is not scientific. There is no such thing as the “rationality” of a belief, there is rationality of action. The rationality of an action can be judged only in terms of evolutionary considerations.

It is therefore my opinion that religion exists to enforce tail risk management across generations, as its binary and unconditional rules are easy to teach and enforce. We have survived in spite of tail risks; our survival cannot be that random.

How much you truly “believe” in something can be manifested only through what you are willing to risk for it.

The only definition of rationality that I’ve found that is practically, empirically, and mathematically rigorous is the following: what is rational is that which allows for survival. Unlike modern theories by psychosophasters, it maps to the classical way of thinking. Anything that hinders one’s survival at an individual, collective, tribal, or general level is, to me, irrational.

Anyone who has survived in the risk-taking business more than a few years has some version of our by now familiar principle that “in order to succeed, you must first survive.”

I can personally vouch for Thorp, who has an unmistakable clarity of mind combined with a depth of thinking that juts out in conversation.

ERGODICITY To take stock: a situation is deemed non-ergodic when observed past probabilities do not apply to future processes. There is a “stop” somewhere, an absorbing barrier that prevents people with skin in the game from emerging from it—and to which the system will invariably tend. Let us call these situations “ruin,” as there is no reversibility away from the condition. The central problem is that if there is a possibility of ruin, cost-benefit analyses are no longer possible. Consider a more extreme example than the casino experiment. Assume a collection of people play Russian roulette a single time for a million dollars—this is the central story in Fooled by Randomness. About five out of six will make money. If someone used a standard cost-benefit analysis, he would have claimed that one has an 83.33 percent chance of gains, for an “expected” average return per shot of $833,333. But if you keep playing Russian roulette, you will end up in the cemetery. Your expected return is … not computable.

Smoking a single cigarette is extremely benign, so a cost-benefit analysis would deem it irrational to give up so much pleasure for so little risk! But it is the act of smoking that kills, at a certain number of packs per year, or tens of thousand of cigarettes—in other words, repeated serial exposure.

If you incur a tiny probability of ruin as a “one-off” risk, survive it, then do it again (another “one-off” deal), you will eventually go bust with a probability of one hundred percent. Confusion arises because it may seem that if the “one-off” risk is reasonable, then an additional one is also reasonable. This can be quantified by recognizing that the probability of ruin approaches 1 as the number of exposures to individually small risks, say one in ten thousand, increases.

The Thorp, Kelly, and Shannon school of information theory requires that, for an investment strategy to be ergodic and eventually capture the return of the market, agents increase their risks as they are winning, but contract after losses, a technique called “playing with the house money.”

But we do not need to be overly paranoid about ourselves; we need to shift some of our worries to bigger things.

Antifragile, the fragility of the system’s components (provided they are renewable and replaceable) is required to ensure the solidity of the system as a whole. If humans were immortals, they would go extinct from an accident, or from a gradual buildup of misfitness. But shorter shelf life for humans allows genetic changes across generations to be in sync with the variability of the environment.

Courage is when you sacrifice your own well-being for the sake of the survival of a layer higher than yours.

Selfish courage is not courage. A foolish gambler is not committing an act of courage, especially if he is risking other people’s funds or has a family to feed.fn5

Warren Buffett. He did not make his billions by cost-benefit analysis; rather, he did so simply by establishing a high filter, then picking opportunities that pass such a threshold. “The difference between successful people and really successful people is that really successful people say no to almost everything,” he said.

make the case for risk loving, for systematic “convex” tinkering, and for taking a lot of risks that don’t have tail risks but offer tail profits.

One may be risk loving yet completely averse to ruin. The central asymmetry of life is: In a strategy that entails ruin, benefits never offset risks of ruin. Further: Ruin and other changes in condition are different animals. Every single risk you take adds up to reduce your life expectancy. Finally: Rationality is avoidance of systemic ruin.