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

by Nassim Nicholas Taleb

To borrow from Warren Buffett, don’t ask the barber if you need a haircut—and don’t ask an academic if what he does is relevant.

If you know all possible conditions of a physical system you can, in theory (though not, as we saw, in practice), project its behavior into the future. But this only concerns inanimate objects. We hit a stumbling block when social matters are involved. It is another matter to project a future when humans are involved, if you consider them living beings and endowed with free will.

If I can predict all of your actions, under given circumstances, then you may not be as free as you think you are. You are an automaton responding to environmental stimuli. You are a slave of destiny. And the illusion of free will could be reduced to an equation that describes the result of interactions among molecules.

would be like studying the mechanics of a clock: a genius with extensive knowledge of the initial conditions and the causal chains would be able to extend his knowledge to the f...

However, if you believe in free will you can’t truly believe in social science and economic projection. You cannot predict how people will act. Except, of course, if there is a trick, and that trick is the cord on which neoclassical economics is suspended. You simply assume that individuals will be rational in the future and thus act predictably. There is a strong link between rationality, predictability, and mathematical tractability. A rational individual will perform a unique set of actions in specified circumstances. There is one and only one answer to the question of how “rational” people satisfying their best interests would act. Rational actors must be coherent: they cannot prefer apples to...

The tragedy is that Paul Samuelson, a quick mind, is said to be one of the most intelligent scholars of his generation. This was clearly a case of very badly invested intelligence. Characteristically, Samuelson intimidated those who questioned his techniques with the statement “Those who can, do science, others do methodology.” If you knew math, you could “do science.” This is reminiscent of psychoanalysts who silence their critics by accusing them of having trouble with their fathers. Alas, it turns out that it was Samuelson and most of his followers who did not know much math, or did not know how to use what math they knew, how to apply it to reality. They only knew enough math to be blinded by it.

Tragically, before the proliferation of empirically blind idiot savants, interesting work had been begun by true thinkers, the likes of J. M. Keynes, Friedrich Hayek, and the great Benoît Mandelbrot, all of whom were displaced because they moved economics away from the precision of second-rate physics. Very sad. One

great underestimated thinker is G.L.S. Shackle, now almost completely obscure, who introduced the notion of “unknowledge,” that is, the unread books in Umberto Eco’s library. It is unusual to see Shackle’s work mentioned at all, ...

Tolstoy said that happy families were all alike, while each unhappy one is unhappy in its own way. People have been shown to make errors equivalent to preferring apples to oranges, oranges to pears, and pears to apples, depending on how the relevant questions are presented to them. The sequence matters! Also, as we have seen with the anchoring example, subjects’ estimates of the number of dentists in Manhattan are influenced by which random number they have just been presented with—the anchor.

What is the most potent use of our brain? It is precisely the ability to project conjectures into the future and play the counterfactual game—“If I punch him in the nose, then he will punch me back right away, or, worse, call his lawyer in New York.” One of the advantages of doing so is that we can let our conjectures die in our stead. Used correctly and in place of more visceral reactions, the ability to project effectively frees us from immediate, first-order natural selection—as opposed to more primitive organisms that were vulnerable to death and only grew by the improvement in the gene pool through the selection of the best. In a way, projecting allows us to cheat evolution: it now takes place in our head, as a series of projections and counterfactual scenarios.

You do not go to medical school the minute you encounter a big health problem; it is less taxing (and certainly safer) for you to consult someone who has already done so. Doctors listen to car mechanics (not for health matters, just when it comes to problems with their cars); car mechanics listen to doctors. We have a natural tendency to listen to the expert, even in fields where there may be no experts.

Someone with a low degree of epistemic arrogance is not too visible, like a shy person at a cocktail party. We are not predisposed to respect humble people, those who try to suspend judgment. Now contemplate epistemic humility. Think of someone heavily introspective, tortured by the awareness of his own ignorance. He lacks the courage of the idiot, yet has the rare guts to say “I don’t know.” He does not mind looking like a fool or, worse, an ignoramus. He hesitates, he will not commit, and he agonizes over the consequences of being wrong. He introspects, introspects, and introspects until he reaches physical and nervous

exhaustion. This does not necessarily mean that he lacks confidence, only that he holds his own knowledge to be suspect. I will call such a person an epistemocrat; the province where the laws are structured with this kind of human fallibility in mind I will call an epistemocracy. The major modern epistemocrat is Montaigne.

Monsieur de Montaigne, Epistemocrat At the age of thirty-eight, Michel Eyquem de Montaigne retired to his estate, in the countryside of southwestern France. Montaigne, which means mountain in Old French, was the name of the estate. The area is known today for the Bordeaux wines, but in Montaigne’s time not many people invested their mental energy and sophistication in wine. Montaigne had stoic tendencies and would not have been strongly drawn to such pursuits anyway. His idea was to write a mod...

Montaigne was well grounded in the classics and wanted to meditate on life, death, education, knowledge, and some not uninteresting biological aspects of human nature (he wondered, for example, whether cripples had more vigorous libidos owing to the richer circulation of blood in their sexual organs). The tower that became his study was inscribed with Greek and Latin sayings, almost all referring to the vulnerability of human knowledge. Its windows offered a wide vista of the surrounding hills. Montaigne’s subject, officially, was himself, but this was mostly as a means to facilitate the discussion; he was not like those corporate executives who write biographies to make a boastful display of their honors and accomplishments. He was mainly interested in discovering things about himself, making us discover things about himself, and presenting matters that ...

Montaigne is quite refreshing to read after the strains of a modern education since he fully accepted human weaknesses and understood that no philosophy could be effective unless it took into account our deeply ingrained imperfections, the limitations of our rationality, the flaws that make us human. It is not that he was ahead of his ...

He was a thinking, ruminating fellow, and his ideas did not spring up in his tranquil study, but while on horseback. He went on long rides and came back with ideas. Montaigne was neither one of the academics of the Sorbonne nor a professional man of letters, and he was not these things on two planes. First, he was a doer; he had been a magistrate, a businessman, and the mayor of Bordeaux before he retired to mull over his life and, mostly, his own knowledge. Second, he was an antidogmatist: he was a skeptic with charm, a fallible, noncommittal, personal, introspective writer, and, primarily, someone who, in the great classical tradition, wanted to be a man. Had he been in a different period, he would have been...

Everyone has an idea of utopia. For many it means equality, universal justice, freedom from oppression, freedom from work (for some it may be the more modest, though no more attainable, society with commuter trains free of lawyers on cell phones). To me utopia is an epistemocracy, a society in which anyone of rank is an epistemocrat, and where epistemocrats manage to be elected. It would be a society governed from the basis of the awareness of ignorance, not knowledge.

Alas, one cannot assert authority by accepting one’s own fallibility. Simply, people need to be blinded by knowledge—we are made to follow leaders who can gather people together because the advantages of being in groups trump the disadvantages of being alone. It has been more profitable for us to bind together in the wrong direction than to be alone in the right

one. Those who have followed the assertive idiot rather than the introspective wise person have passed us some of their genes. This is apparent from a soc...

The Black Swan asymmetry allows you to be confident about what is wrong, not about what you believe is right. Karl Popper was once asked whether one “could falsify falsification” (in other words, if one could be skeptical about skepticism). His answer was that he threw students out of his lectures for asking far more intelligent questions than that one. Quite tough, Sir Karl was.

Accordingly, an element in the mechanics of how the human mind learns from the past makes us believe in definitive solutions—yet not consider that those who preceded us thought that they too had definitive solutions. We laugh at others and we don’t realize that someone will be just as justified in laughing at us on some not too remote day. Such a realization would entail the recursive, or second-order, thinking that I mentioned in the Prologue; we are not good at it.

They see others as inanimate objects, like machines, moved by explicit rules. They cannot perform such simple mental operations as “he knows that I don’t know that I know,” and it is this inability that impedes their social skills. (Interestingly, autistic subjects, regardless of their “intelligence,” also exhibit an inability to comprehend uncertainty.)

Psychologists have studied this kind of misprediction with respect to both pleasant and unpleasant events. We overestimate the effects of both kinds of future events on our lives. We seem to be in a psychological predicament that makes us do so. 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.

We grossly overestimate the length of the effect of misfortune on our lives. You think that the loss of your fortune or current position will be devastating, but you are probably wrong. More likely, you will adapt to anything, as you probably did after past misfortunes. You may feel a sting, but it will not be as bad as you expect. This kind of misprediction may have a purpose: to motivate us to perform important acts (like buying new cars or getting rich) and to prevent us from taking certain unnecessary risks. And it is part of a more general problem: we humans are supposed to fool ourselves a little bit here and there. According to Trivers’s theory of self-deception, this is supposed to orient us favorably toward the future. But self-deception is not a desirable feature outside of its natural domain. It prevents us from taking some unnecessary risks—but we saw in

Chapter 6 how it does not as readily cover a spate of modern risks that we do not fear because they are not vivid, such as investment risks, envi...

Consider the following thought experiment borrowed from my friends Aaron Brown and Paul Wilmott: Operation 1 (the melting ice cube): Imagine an ice cube and consider how it may melt over the next two hours while you play a few rounds of poker with your friends. Try to envision the shape of the resulting puddle. Operation 2 (where did the water come from?): Consider a puddle of water on the floor. Now try to reconstruct in your mind’s eye the shape of the ice cube it may once have been. Note that the puddle may not have necessarily originated from an ice cube. The second operation is harder. Helenus indeed had to have skills.

The difference between these two processes resides in the following. If you have the right models (and some time on your hands, and nothing better to do) you can predict with great precision how the ice cube will melt—this is

a specific engineering problem devoid of complexity, easier than the one involving billiard balls. However, from the pool of water you can build infinite possible ice cubes, if there was in fact an ice cube there at all. 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 us...

The process from the butterfly to the hurricane is greatly simpler than the reverse process from the hurricane to the potential butterfly.

Nonpractitioners of randomness do not understand the subtlety. Often, in conferences when they hear me talk about uncertainty and randomness, philosophers, and sometimes mathematicians, bug me about the least relevant point, namely whether the randomness I address is “true randomness” or “deterministic chaos” that masquerades as randomness. A true random system is in fact random and does not have predictable properties. A chaotic system has entirely predictable properties, but they are hard to know. So my answer to them is dual. a) There is no functional difference in practice between the two since we will never get to make the distinction—the difference is mathematical, not practical. If I see a pregnant woman, the sex of her child is a purely random matter to me (a 50 percent chance for either sex)—but not to her doctor, who might have done an ultrasound. In practice, randomness is fundamentally incomplete information. b) The mere fact that a person is talking about the difference implies that he has never made a meaningful decision under uncertainty—which is why he does not realize that they are indistinguishable in practice. Randomness, in the end, is just unknowledge. The world is opaque and appearances fool us.

History is useful for the thrill of knowing the past, and for the narrative (indeed), provided it remains a harmless narrative. One should learn under severe caution. History is certainly not a place to theorize or derive general knowledge, nor is it meant to help in the future, without some caution. We can get negative confirmation from history, which is invaluable, but we get plenty of illusions of knowledge along with it.

from it. Learn to read history, get all the knowledge you can, do not frown on the anecdote, but do not draw any causal links, do not try to reverse engineer too much—but if you do, do not make big scientific claims. Remember that the empirical skeptics had respect for custom: they used it as a default, a basis for action, but not for more than that. This clean approach to the past they called epilogism.*

You see the same with all theoreticians of history, whether Ibn Khaldoun, Marx, or Hegel. The more we try to turn history into anything other than an enumeration of accounts to be enjoyed with minimal theorizing, the more we get into trouble. Are we so plagued with the narrative fallacy?† We may have to wait for a generation of skeptical-empiricist historians capable of understanding the difference between a forward process and a reverse one. Just as Popper attacked the historicists in their making claims about the future, I have just presented the weakness of the historical approach in knowing the past itself.

Yogi Berra might have a theory of epilogism with his saying, “You can observe a lot by just watching.”

The demand for certainty is one which is natural to man, but is nevertheless an intellectual vice. If you take

your children for a picnic on a doubtful day, they will demand a dogmatic answer as to whether it will be fine or wet, and be disappointed in you when you cannot be sure. … But so long as men are not trained [emphasis mine] to withhold judgment in the absence of evidence, they will be led astray by cocksure prophets … For the learning of every virtue there is an appropriate discipline, and for the learning of suspended judgment the best discipline is philosophy. The reader may be surprised that I disagree. It is hard to disagree that the demand for certainty is an intellectual vice. It is hard to disagree that we can be led astray by some cocksure prophet. Where I beg to differ with the great man is that I do not believe in the track record of advice-giving “philosophy” in helping us deal with the problem; nor do I believe that virtues can be easily taught; nor do I urge people to strain in order to avoid making a judgment. Why? Because we have to deal with humans as humans. We cannot teach people to withhold judgment; judgments are embedded in the way we view objects. I do not see a “tree;” I see a pleasant or an ugly tree. It is not possible

without great, paralyzing effort to strip these small values we attach to matters. Likewise, it is not possible to hold a situation in one’s head without some element of bias. Something in our ...

The lesson for the small is: be human! Accept that being human involves some amount of epistemic arrogance in running your affairs. Do not be ashamed of that. Do not try to always withhold judgment—opinions are the stuff of life. 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.*

What you should avoid is unnecessary dependence on large-scale harmful predictions—those and only those. Avoid the big subjects that may hurt your future: be fooled in small matters, not in the large. Do not listen to economic forecasters or to predictors in social science (they are mere entertainers), but do make your own forecast for the picnic. By all means, demand certainty for the next picnic; but avoid government social-security forecasts for the year 2040.

Know how to rank beliefs not according to their plausibility but by th...

Be Prepared The reader might feel queasy reading about these general failures to see the future and wonder what to do. But if you shed the idea of full predictability, there are plenty of things to do provided you remain conscious of their limits. Knowing that you cannot predict does not mean that you cannot benefit from unpredictability. The bottom line: be prepared! Narrow-minded prediction has an analgesic or the...

This same point can be generalized to life: maximize the serendipity around you.

Sextus Empiricus retold the story of Apelles the Painter, who, while doing a portrait of a horse, was attempting to depict the foam from the horse’s mouth. After trying very hard and making a mess, he gave up and, in irritation, took the sponge he used for cleaning his brush and threw it at the picture. Where the sponge hit, it left a perfect representation of the foam. Trial and error means trying a lot. In The Blind Watchmaker, Richard Dawkins brilliantly illustrates this notion of the world without grand design, moving by small incremental random changes. Note a slight disagreement on my part that does not change the story by much: the world, rather, moves by large incremental random changes.

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.

Furthermore, this trade-off between volatility and risk can show up in careers that give the appearance of being stable, like jobs at IBM until the 1990s. When laid off, the employee faces a total void: he is no longer fit for anything else. The same holds for those in protected industries. On the other hand, consultants can have volatile earnings as their clients’ earnings go up and down, but face a lower risk of starvation, since their skills match demand—fluctuat nec mergitur (fluctuates but doesn’t sink). Likewise, dictatorships that do not appear volatile, like, say, Syria or Saudi Arabia, face a larger risk of chaos than, say, Italy, as the latter has been in a state of continual political turmoil since the second war. I learned about this problem from the finance industry, in which we see “conservative” bankers sitting on a pile of dynamite but fooling themselves because their operations seem dull and lacking in volatility.

I am trying here to generalize to real life the notion of the “barbell” strategy I used as a trader, which is as follows. If you know that you are vulnerable to prediction errors, and if you accept that most “risk measures” are flawed, because of the Black Swan, then your strategy is to be as hyperconservative and hyperaggressive as you can be instead of being mildly aggressive or conservative. Instead of putting your money in “medium risk” investments (how do you know it is medium risk? by listening to tenure-seeking “experts”?), you need to put a portion, say 85 to 90 percent, in extremely safe instruments, like Treasury bills—as safe a class of instruments as you can manage to find on this planet. The remaining 10 to 15 percent you put in extremely speculative bets, as leveraged as possible (like options), preferably venture capital–style portfolios.* That

“Nobody Knows Anything” The legendary screenwriter William Goldman was said to have shouted “Nobody knows anything!” in relation to the prediction of movie sales. Now, the reader may wonder how someone as successful as Goldman can figure out what to do without making predictions. The answer stands perceived business logic on its head. He knew that he could not predict individual events, but he was well aware that the unpredictable, namely a movie turning into a blockbuster, would benefit him immensely.

First, make a distinction between positive contingencies and negative ones. Learn to distinguish between those human undertakings in which the lack of predictability can be (or has been) extremely beneficial and those where the failure to understand the future caused harm. There are both positive and negative Black Swans. William Goldman was involved in the movies, a positive–Black Swan business. Uncertainty did occasionally pay off there.

A negative–Black Swan business is one where the unexpected can hit hard and hurt severely. If you are in the military, in catastrophe insurance, or in homeland security, you face only downside. Likewise, as we saw in Chapter 7, if you are in banking and lending, surprise outcomes are likely to be negative for you. You lend, and in the best of circumstances you get your loan back—but you may lose all of your money if the borrower defaults. In the event that the borrower enjoys great financial success, he is not likely to offer you an additional dividend.