The Black Swan Problem

Taleb, Nassim N. The Black Swan: The Impact of the Highly Improbable. New York: Random House Trade Paperbacks, 2011.

The Book of Job records a divine Black Swan. Without warning, Job loses his children, possessions, health, and the approval of his wife and friends. These events meet the Black Swan’s initial criteria: its unexpectedness and big consequences. The rest of the book concerns Job and his “friends” trying to figure out why Job’s Black Swan event happened. This is the Black Swan’s third criterion: it is only explainable retrospectively. Job’s friends think Job must have sinned because God punishes sinners. Job knows he’s served God and wonders why God is punishing him. Both claims are logical. Sin has consequences, and so does serving God. Yet both Job and his friends are wrong.  No one brings up Satan, who had challenged God concerning Job. The story we’re given—the one Job and his friends never learn—is that Job suffered because he was good. Job and his friends didn’t know what they didn’t know. As a result, they were overconfident in what they did know. When God finally replies to Job, He does not explain the Black Swan. Instead, God confronts Job with his own ignorance.

Nassim Nicholas Taleb’s book is about living in a world where Black Swans happen regularly. We know this in our heads but don’t feel it in our guts, so he wants to confront us with our own ignorance. Too often, we are naïve empiricists, trusting our own experiences and (falsely) drawing conclusions from them. Consider the turkey who is unknowingly being raised for slaughter. For a thousand days, the turkey gets pampered and fed. On the thousand and first day, it has its throat slit and gets served for dinner. Nothing in the turkey’s direct experience prepared it for that day of reckoning. If its life were plotted on a graph, it would look like a steadily increasing line suddenly falling off a cliff. Or consider the Black Swan of the book’s title. We can count as many white swans as we want, but we can never confirm the statement that all swans are white. One black swan disproves that generalization.

We want to live in Mediocristan, Taleb’s name for the domain of the Bell Curve and laboratory probability, a place where one stray data point doesn’t do much to affect a set’s total. In Mediocristan, results are symmetrical, and two people with a total net worth of $1 million probably have $500k each. In Extremistan, Taleb’s name for the world we’re living in, one more likely has $50k, and the other has $950k. The world of Extremistan is asymmetrical. Job has everything. Job loses everything. In such a world, Taleb encourages skeptical empiricism. This means acknowledging what you don’t know. Why, for instance, have a large library with 30,000 volumes? As a constant reminder of all the books you haven’t read.

In Extremistan, you must remain skeptical about what you do know. It’s easier but more dangerous to keep looking for a white swan that confirms your generalization than entertain the idea that swans could come in a different color. Stories handicap us too. It’s hard for us not to write a story after a positive or negative black swan. We ignore the silent evidence (we can only see the surviving examples) and mistakenly equate the absence of evidence (“I’ve never seen a black swan!”) with evidence of absence (“No Black Swans exist!”). Having too much information at our disposal hurts us, especially when it makes us overconfident in our predictions. Finally, we have a hard time being consistent. We may be good skeptical empiricists in one domain (e.g. politics) and completely forget those same principles in others (e.g. investment strategies).

(It’s worth noting that not all Black Swans are bad. An example of a Talebian investment strategy? Put 85% in T-bills and 15% in venture capital investments which offer asymmetrical awards. On the other hand, be wary of the stock market, especially when packaged as part of a “safe” investment strategy.)  

Taleb made his living as a trader before writing Fooled By Randomness in 2000. He has subsequently moved into academia while retaining his skepticism about academics in general. The funniest parts of Fooled By Randomness were when he lampooned blowhard intellectuals. In this book, he goes after academics (especially economists) and politicians. He has people he likes and doesn’t like, but predicting who he’ll like is hard (the problem of induction!). He praises Hayek and then praises Keynes, arguing that Austrians and Keynesians diagnose the same problem but have different solutions. He praises Karl Popper, the arch-twentieth century philosophical skeptic, then praises Blaise Pascal, a French theologian and mathematician.  

As should be clear, this is not your average business book, a genre Taleb disdains. In interviews, Taleb said he purposefully made the book confusing to expose reviewers who had only read the opening. The book is filled with fictitious characters—the suddenly successful novelist Yevgenia Nikolayevna Krasnova, the mobster Fat Tony, and the day trader Nero—who help Taleb make Black Swan into a story as much as a series. Taleb also talks about his experience growing up during the Lebanese Civil War. The book has earned retrospective credibility for predicting the financial crisis of 2008 while remaining skeptical about the prediction. Any one of these features would make it unique. To read them all jumbled up is both engaging and occasionally annoying.

When Taleb is focused, he’s extraordinarily insightful. I hope I remember the following story he tells about confirmation bias for the rest of my life. Psychologists gave their subjects a three-number sequence—4,6,8—and asked them to generalize the rule that had produced the sequence. Before offering their conclusion, they were allowed to test as many 3-number sequences as possible. Most participants incorrectly guessed the rule because their test sequences simply confirmed their pattern from one sample: 10, 12, 14 or 20, 22, 24, etc. They didn’t try sequences they thought might be wrong. The actual rule? Only that the sequence increased with each number, not that they increased with a set increment. 10, 9, 7 wouldn’t have worked, but 10, 35, 36 would have, as would 8, 9, 10.

Some final words about Job and Black Swans? Loss and gain are not symmetrical. Taleb points to studies that show we would feel better remaining where we are than having gotten $1 million and subsequently lost $950k of it, although we would be up $50k in the second scenario. Job’s gains at the end of the book are not symmetrical. Yes, Job gets twice as many possessions as he had initially. He even fathers ten more children. But he can’t get back the ten children that died. Nor will he forget the reaction of his wife and friends. Finally, he didn’t discover the real reason for what happened. His lesson was admitting he didn’t know as much as he thought he knew. His consolation? He served the God of Black Swans and was granted the chance to see “his children and their children to the fourth generation.” If you read the Old Testament, you know that this kind of continuity, as ordinary as it appears, is a Black Swan. Who could have predicted that?