Sunday, 13 September 2009

Interesting People & Interesting Books: Nassim Taleb & The Black Swan

In his book The Black Swan, before the explosion of the subprime crisis, he wrote:

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 crises 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.

Seems to reflect reality, isn’t it?

We are talking about Nassim Nicholas Taleb. Today famous for his two bestselling books Fooled by Randomness and The Black Swan. It would be difficult to label him. He is surely a writer/essayist and a researcher, but not only. He’s also a quant, the term used to describe experts in mathematical finance, or better quantitative analysts. He in fact works in this field. But this would not anyway be enough to describe him accurately. He define himself as a sceptical empiricist. In his web site we can find this description that does a good job in giving an idea about him: My major hobby is teasing people who take themselves & the quality of their knowledge too seriously & those who don’t have the courage to sometimes say: I don’t know...." (You may not be able to change the world but can at least get some entertainment & make a living out of the epistemic arrogance of the human race. This quote tells more about him than any other label.

Taleb was born in 1960 in Lebanon from a wealthy and well-educated family. He later studied in various countries and universities: MBA from Wharton School (Pennsylvania, US) and Ph.D from the University of Paris. As a result of his multi-national background he speaks English, French and Arabic. But he also has a a conversational fluency in Italian and Spanish, and reads classical texts in Greek, Latin, Aramaic, and ancient Hebrew. Other things that struck me when reading one of his books are the breadth and depth of his knowledge. I mean, if it happens to you to hold in your hands The Black Swan, take a look at the bibliography. It’s incredibly huge and varied believe me. This means that, not only he has a strong financial background because of his studies, but that he also spends most of his time reading and studying all kinds of books. Among the people he talks about, names such as Mandelbrot, Popper, Plato, Yogi Berra, Sextus Empiricus, Bacon, Hume, Russel and other eminent writers, scientists and philosophers.

Taleb’s main worrying seems to be that of epistemology. He doesn’t like the fact that the way in which we know the world and therefore act accordingly is frequently so wrong. That’s why the first part of his book The Black Swan is all dedicated to dismantle some of the patterns of thinking that we adopt in our everyday life when dealing with all kinds of stuff, mainly knowledge-related. Black Swans are usually strongly-influential and unexpected events that we can only “predict” (i.e.: Damn! I knew it! syndrome) only once they have already happened (e.g.: 9/11, the rise of Google, world wars, the success of the Harry Potter saga, you name it). The metaphor of the Black Swan is a tribute to Karl Popper’s concept of falsification. In fact: until a certain point in history man believed that swans could only be white. Thousands and thousands of observations were, on a daily basis, confirming that belief. One day, though, when Australia was discovered (XVII century), also black swans were discovered. Thousands of years of observations were invalidated from a single observation!

According to Taleb we are so bad at predicting things, but we do not want to acknowledge that! In fact, many of us think we live in Mediocristan, whereas evidence shows that rather we live in Extremistan. Basically, he explains this other metaphor with the following straightforward example: Take 1000 people and gather them together in a baseball field. After that you weigh them and get the overall weight Now, try to imagine the heaviest human being you can think of (that can still be called a human being) entering the room and add him to the scale. Despite of his huge size he would still represent a small percentage of the overall weight and would only slightly affect the average. This is Mediocristan: a place where the extraordinary events have a small effect on the total. A Gaussian world let’s say. Now, imagine Bill Gates enters the baseball field. What would be the effect on the average worth? Huge. That’s Extremistan.

In his book Taleb, not only exlain the nature of black swans, but also tell us why we have such a hard time recognising them. It’s up to you to read the book and discover more about it! Now, in fact, I fear that this post is becoming dangerously too long to read without hating me. I hope I was able to stimulate your interest. Therefore let me conclude, by strongly suggesting to read this book if you are interested in knowing more about humans and the way in which the world works.