The Black Swan

The Black Swan by Nassim Nicholas Taleb

Category: Philosophy Grade: B+

This book made my head hurt.

Taleb, by background, is a trader. I guess I hadn't really grasped the fact from the reviews and the jacket cover that this was really a philosophy book. That made it, at times, hard to follow. In addition, Taleb's tone is very confrontational. He's obviously not out to win friends among the financial and philosophical community. He even trashes icons like the economist Paul Samuelson and his followers.

Taleb's basic premise is that most things -- life, history, the financial markets - are driven not by predictable, analyzable continuity (or by bell curves), but by Black Swans. The term comes from the fact that, for centuries, most scientist believed that all swans were white based on thousands and thousands of observations. I.e. nobody had ever seen a swan that wasn't white so, therefore, all swans must be white. This theory had to be thrown out when the unexpected happened -- scientists found black swans in Australia. More specifically, a Black Swan, per Taleb, has three characteristics -- its unpredictable, it has major impact and, most of the time, it can be analyzed (not necessarily correctly) in hindsight. The best examples of Black Swan in the recent past are 9/11 and Katrina (and, more personally, the massive floodings in Marble Falls this summer). Note, not all Black Swans are negative. Again from personal experience, the success of AOL has to be considered a Black Swan - one that worked out pretty well for me.

Taleb points out that predicting based on experience is an extremely dangerous thing to do. Essentially, "if you don't study history, you're doomed to repeat it" doesn't work for him. The classic example he uses is the "Thanksgiving turkey" scenario. If you're a turkey, for a thousand days you're pampered and well fed. After a thousand observations, it's reasonable for you, the turkey, to assume that tomorrow will be another day like yesterday. Surprise, surprise - instead of getting dinner, you are dinner on the 1001st day! The general conclusions from this is that you can't draw definitive positive conclusions from any number of positive observations. You can, however, draw negative conclusions from a single negative observation. For example, thousands of white swans don't prove that all swans are white, while a single black swan proves that not all swans are white. He also warns against transposition errors -- "not all swans are white" is not the same as "all swans are not white".

From a practical point of view, Taleb's conclusion is that professional predictors are useless. In fact, he claims that they're worse than useless since they don't accept the fact that they could be wrong. Since a lot of research in the financial world is devoted to building more and more elaborate economic and market models, this is naturally a controversial position.

Ultimately, of course, since Black Swans are, by definition, unpredictable, you can't really plan for them. You can, however, plan on the assumption that some Black Swan will happen. On the negative side, most of us do this -- we buy insurance. Insurance always seems like a useless thing to do, until the Black Swan happens. Just ask the uninsured Katrina victims. On the positive side, you can put yourself in position to take advantage of positive Black Swans - e.g. join start up companies.

Reading contrarians like Taleb is definitely worthwhile. I actually happen to identify with his writings, but even if he just makes you think more critically, he's worth reading.