The Black Swan: The Impact of the Highly Improbable (Incerto, #2)

by Nassim Nicholas Taleb

This predicament is called “anticipated utility” by Danny Kahneman and “affective forecasting” by Dan Gilbert. The point is not so much that we tend to mispredict our future happiness, but rather that we do not learn recursively from past experiences. We have evidence of a mental block and distortions in the way we fail to learn from our past errors in projecting the future of our affective states.

The first direction, from the ice cube to the puddle, is called the forward process. The second direction, the backward process, is much, much more complicated. The forward process is generally used in physics and engineering; the backward process in nonrepeatable, nonexperimental historical approaches.

Randomness, in the end, is just unknowledge. The world is opaque and appearances fool us.

For the learning of every virtue there is an appropriate discipline, and for the learning of suspended judgment the best discipline is philosophy.

It is hard to disagree that the demand for certainty is an intellectual vice.

Indeed, if philosophy were that effective, the self-help section of the local bookstore would be of some use in consoling souls experiencing pain—but it isn’t. We forget to philosophize when under strain.

Do not try to avoid predicting—yes, after this diatribe about prediction I am not urging you to stop being a fool. Just be a fool in the right places.*

Know how to rank beliefs not according to their plausibility but by the harm they may cause.

My colleague Mark Spitznagel understood that we humans have a mental hang-up about failures: “You need to love to lose” was his motto. In fact, the reason I felt immediately at home in America is precisely because American culture encourages the process of failure, unlike the cultures of Europe and Asia where failure is met with stigma and embarrassment. America’s specialty is to take these small risks for the rest of the world, which explains this country’s disproportionate share in innovations. Once established, an idea or a product is later “perfected” over there.

As Yogi Berra, another great thinker, said, “You got to be very careful if you don’t know where you’re going, because you might not get there.”

Seize any opportunity, or anything that looks like opportunity. They are rare, much rarer than you think. Remember that positive Black Swans have a necessary first step: you need to be exposed to them. Many people do not realize that they are getting a lucky break in life when they get it.

Work hard, not in grunt work, but in chasing such opportunities and maximizing exposure to them. This makes living in big cities invaluable because you increase the odds of serendipitous encounters—you gain exposure to the envelope of serendipity.

Diplomats understand that very well: casual chance discussions at cocktail parties usually lead to big breakthroughs—not dry correspondence or telephone conversations. Go to parties! If you’re a scientist, you will chance upon a remark that might spark new research. And if you are autistic, send your associates to these events.

The Achilles’ heel of capitalism is that if you make corporations compete, it is sometimes the one that is most exposed to the negative Black Swan that will appear to be the most fit for survival. Also recall from the footnote on Ferguson’s discovery in Chapter 1 that markets are not good predictors of wars. No one in particular is a good predictor of anything. Sorry.

“There are some people who, if they don’t already know, you can’t tell ’em,” as the great philosopher of uncertainty Yogi Berra once said. Do not waste your time trying to fight forecasters, stock analysts, economists, and social scientists, except to play pranks on them. They are considerably easy to make fun of, and many get angry quite readily. It is ineffective to moan about unpredictability: people will continue to predict foolishly, especially if they are paid for it, and you cannot put an end to institutionalized frauds. If you ever do have to heed a forecast, keep in mind that its accuracy degrades rapidly as you extend it through time.

All these recommendations have one point in common: asymmetry. Put yourself in situations where favorable consequences are much larger than unfavorable ones.

Indeed, the notion of asymmetric outcomes is the central idea of this book: I will never get to know the unknown since, by definition, it is unknown. However, I can always guess how it might affect me, and I should base my decisions around that.

This idea is often erroneously called Pascal’s wager, after the philosopher and (thinking) mathematician Blaise Pascal. He presented it something like this: I do not know whether God exists, but I know that I have nothing to gain from being an atheist if he does not exist, whereas...

Pascal’s argument is severely flawed theologically: one has to be naïve enough to believe that God would not penalize us for false belief. Unless, of course, one is taking the quite restrictive view of a naïve God. (Bertrand Russell was reported to have claimed tha...

But the idea behind Pascal’s wager has fundamental applications outside of theology. It stands the entire notion of knowledge on its head. It eliminates the need for us to understand the probabilities of a rare event (there are fundamental limits to our knowledge of these); rather, we can focus on the payoff and benefits of an event if it takes place. The probabilities of very rare events are not computable; the effect of an event on us is considerably easier to ascertain (the rarer the event, the fuzzier the odds). We can have a clear idea of the consequences of an event, even if we do not know how likely it is to occur. I don’t know the odds of an earthquake, but I can imagine how San Francisco might be affected by one. This idea that in order to...

You can build an overall theory of decision making on this idea. All you have to do is mitigate the consequences. As I said, if my portfolio is exposed to a market crash, the odds of which I can’t compute, all I have to do is buy insurance, or get out and inves...

I’ll sum up this long section on prediction by stating that we can easily narrow down the reasons we can’t figure out what’s going on. There are: a) epistemic arrogance and our corresponding future blindness; b) the Platonic notion of categories, or how people are fooled by reductions, particularly if they have an academic degree in an expert-free discipline; and, finally c) flawed tools of inference, particularly the Black Swan–free tools from Mediocristan.

The more socialist a country’s orientation, the easier it was for the large corporate monsters to stick around. Why did capitalism (and not socialism) destroy these ogres? In other words, if you leave companies alone, they tend to get eaten up. Those in favor of economic freedom claim that beastly and greedy corporations pose no threat because competition keeps them in check. What I saw at the Wharton School convinced me that the real reason includes a large share of something else: chance. But when people discuss chance (which they rarely do), they usually only look at their own luck. The luck of others counts greatly.

Capitalism is, among other things, the revitalization of the world thanks to the opportunity to be lucky. Luck is the grand equalizer, because almost everyone can benefit from it. The socialist governments protected their monsters and, by doing so, killed potential newcomers in the womb.

Randomness has the beneficial effect of reshuffling society’s cards, knocking down the big guy.

What Anderson saw is that the Web causes something in addition to concentration. The Web enables the formation of a reservoir of proto-Googles waiting in the background. It also promotes the inverse Google, that is, it allows people with a technical specialty to find a small, stable audience.

One highlight of the year 2006 was to find in my mailbox a draft manuscript of a book called Cognitive Diversity: How Our Individual Differences Produce Collective Benefits, by Scott Page. Page examines the effects of cognitive diversity on problem solving and shows how variability in views and methods acts like an engine for tinkering. It works like evolution.

A similar effect is taking place in economic life. I spoke about globalization in Chapter 3; it is here, but it is not all for the good: it 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 now interrelated. So the financial ecology is swelling into gigantic, incestuous, bureaucratic banks (often Gaussianized in their risk measurement)—when one falls, 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. I rephrase here: we will have fewer but more severe crises. The rarer the event, the less we know about its odds. It means that we know less and less about the possibility of a crisis.

It has even been shown, by Michael Marmot of the Whitehall Studies, that those at the top of the pecking order live longer, even when adjusting for disease. Marmot’s impressive project shows how social rank alone can affect longevity. It was calculated that actors who win an Oscar tend to live on average about five years longer than their peers who don’t. People live longer in societies that have flatter social gradients. Winners kill their peers as those in a steep social gradient live shorter lives, regardless of their economic condition.

The chapter after that will probe the misuse of the Gaussian in socioeconomic life and “the need to produce theories.”

This is like Gaussian randomness: the reason my cup of coffee does not jump is that the sum of all of its moving particles becomes smooth. Likewise, you reach certainties by adding up small Gaussian uncertainties: this is the law of large numbers.

I thought that finance and economics were just a place where one learned from various empirical phenomena and filled up one’s bank account with f*** you cash before leaving for bigger and better things.

Now, why aren’t statisticians who work with historical data aware of this problem? First, they do not like to hear that their entire business has been canceled by the problem of induction. Second, they are not confronted with the results of their predictions in rigorous ways. As we saw with the Makridakis competition, they are grounded in the narrative fallacy, and they do not want to hear it.

Schützenberger insisted on the clear-cut distinction in the French language between hasard and fortuit. Hasard, from the Arabic az-zahr, implies, like alea, dice—tractable randomness; fortuit is my Black Swan—the purely accidental and unforeseen.

we handle matters that belong to Extremistan, but treated as if they belonged to Mediocristan, as an “approximation.”

The Nobel Committee could have tested the Sharpe and Markowitz models—they work like quack remedies sold on the Internet—but nobody in Stockholm seems to have thought of it. Nor did the committee come to us practitioners to ask us our opinions; instead it relied on an academic vetting process that, in some disciplines, can be corrupt all the way to the marrow. After that award I made a prediction: “In a world in which these two get the Nobel, anything can happen. Anyone can become president.”

So the Gaussian* pervaded our business and scientific cultures, and terms such as sigma, variance, standard deviation, correlation, R square, and the eponymous Sharpe ratio, all directly linked to it, pervaded the lingo. If you read a mutual fund prospectus, or a description of a hedge fund’s exposure, odds are that it will supply you, among other information, with some quantitative summary claiming to measure “risk.” That measure will be based on one of the above buzzwords derived from the bell curve and its kin. Today, for instance, pension funds’ investment policy and choice of funds are vetted by “consultants” who rely on portfolio theory. If there is a problem, they can claim that they relied on standard scientific method.

Since I was questioning their entire business, it was understandable that I drew all manner of insults: “obsessive,” “commercial,” “philosophical,” “essayist,” “idle man of leisure,” “repetitive,” “practitioner” (this is an insult in academia), “academic” (this is an insult in business).

An ad hominem attack against an intellectual, not against an idea, is highly flattering. It indicates that the person does not have anything intelligent to say about your message.

Now, elegant mathematics has this property: it is perfectly right, not 99 percent so. This property appeals to mechanistic minds who do not want to deal with ambiguities. Unfortunately you have to cheat somewhere to make the world fit perfect mathematics; and you have to fudge your assumptions somewhere. We have seen with the Hardy quote that professional “pure” mathematicians, however, are as honest as they come.

I will go further: people who worry about pennies instead of dollars can be dangerous to society. They mean well, but, invoking my Bastiat argument of Chapter 8, they are a threat to us. They are wasting our studies of uncertainty by focusing on the insignificant. Our resources (both cognitive and scientific) are limited, perhaps too limited. Those who distract us increase the risk of Black Swans.

They may also believe that nationality matters (they always stick “French,” “German,” or “American” in front of a philosopher’s name, as if this has something to do with anything he has to say).

I can’t do anything to stop the sun from nonrising tomorrow (no matter how hard I try), I can’t do anything about whether or not there is an afterlife, I can’t do anything about Martians or demons taking hold of my brain. But I have plenty of ways to avoid being a sucker. It is not much more difficult than that.

I conclude Part Three by reiterating that my antidote to Black Swans is precisely to be noncommoditized in my thinking. But beyond avoiding being a sucker, this attitude lends itself to a protocol of how to act—not how to think, but how to convert knowledge into action and figure out what knowledge is worth. Let us examine what to do or not do with this in the concluding section of this book.

I worry less about advertised and sensational risks, more about the more vicious hidden ones. I worry less about terrorism than about diabetes, less about matters people usually worry about because they are obvious worries, and more about matters that lie outside our consciousness and common discourse

Snub your destiny. I have taught myself to resist running to keep on schedule. This may seem a very small piece of advice, but it registered. In refusing to run to catch trains, I have felt the true value of elegance and aesthetics in behavior, a sense of being in control of my time, my schedule, and my life. Missing a train is only painful if you run after it! Likewise, not matching the idea of success others expect from you is only painful if that’s what you are seeking.

In Black Swan terms, this means that you are exposed to the improbable only if you let it control you. You always control what you do; so make this your end.

We are quick to forget that just being alive is an extraordinary piece of good luck, a remote event, a chance occurrence of monstrous proportions.

Over the past three years, my life experienced a bit of change, mostly for the better. Like parties, a book puts you on the envelope of serendipity; it even gets you invited to more parties. During my dark days, I was called a trader in Paris (something extremely vulgaire), a philosopher in London (meaning too theoretical), a prophet in New York (dissingly, because of my then false prophecy), and an economist in Jerusalem (something very materialistic). I now saw myself dealing with the stress of having to live up to the wholly undeserved designations of a prophet in Israel (a very, very ambitious project), a philosophe in France, an economist in London, and a trader in New York (where it is respectable).

People say things in person they would never put in print.