Нассим Талеб - The Black Swan. The Impact of the Highly Improbable

The psychologist Simon Baron-Cohen has produced much research distinguishing between polar extremes in people’s temperament with respect to two faculties: ability to systematize, and ability to empathize and understand others. According to his research, purely systematizing persons suffer from a lack of theory of mind; they are drawn to engineering and similar occupations (and when they fail, to, say, mathematical economics); empathizing minds are drawn to more social (or literary) professions. Fat Tony, of course, would fall in the more social category. Males are overrepresented in the systematizing category; females dominate the other extreme.

Note the unsurprising, but very consequential fact that people with Asperger syndrome are highly averse to ambiguity.

Research shows that academics are overrepresented in the systematizing, Black-Swan-blind category; these are the people I called “Locke’s madmen” in Chapter 17. I haven’t seen any formal direct test of Black Swan foolishness and the systematizing mind, except for a calculation George Martin and I made in 1998, in which we found evidence that all the finance and quantitative economics professors from major universities whom we tracked and who got involved in hedge fund trading ended up making bets against Black Swans, exposing themselves to blowups. This preference was nonrandom, since between one third and one half of the nonprofessors had that investment style at the time. The best known such academics were, once again, the “Nobel”-crowned Myron Scholes and Robert C. Merton, whom God created so that I could illustrate my point about Black Swan blindness. *They all experienced problems during the crisis, discussed in that chapter, that brought down their firm Long Term Capital Management. Note that the very same people who make a fuss about discussions of Asperger as a condition not compatible with risk-bearing and the analysis of nonexplicit off-model risks, with its corresponding dangers to society, would be opposed to using a person with highly impaired eyesight as the driver of a school bus. All I am saying is that just as I read Milton, Homer, Taha Husain, and Borges (who were blind) but would prefer not to have them drive me on the Nice–Marseilles motorway, I elect to use tools made by engineers but prefer to have society’s risky decisions managed by someone who is not affected with risk-blindness.

FUTURE BLINDNESS REDUX

Now recall the condition, described in Chapter 12, of not properly transferring between past and future, an autism-like condition in which people do not see second-order relations—the subject does not use the relation between the past’s past and the past’s future to project the connection between today’s past and today’s future. Well, a gentleman called Alan Greenspan, the former chairman of the U.S. Federal Reserve Bank, went to Congress to explain that the banking crisis, which he and his successor Bernanke helped cause, could not have been foreseen because it “had never happened before.” Not a single member of congress was intelligent enough to shout, “Alan Greenspan, you have never died before, not in eighty years, not even once; does that make you immortal?” The abject Robert Rubin, the bankster I was chasing in Section II, a former secretary of the Treasury, used the same argument—but the fellow had written a long book on uncertainty (with, ironically, my publisher and the same staff used for The Black Swan) . *

I discovered (but by then I was not even surprised) that no researcher has tested whether large deviations in economics can be predicted from past large deviations—whether large deviations have predecessors, that is. This is one of the elementary tests missing in the field, as elementary as checking whether a patient is breathing or whether a lightbulb is screwed in, but characteristically nobody seems to have tried to do it. It does not take a lot of introspection to figure out that big events don’t have big parents: the Great War did not have a predecessor; the crash of 1987, in which the market went down close to 23 percent in a single day, could not have been guessed from its worst predecessor, a one-day loss of around 10 percent—and this applies to almost all such events, of course. My results were that regular events can predict regular events, but that extreme events, perhaps because they are more acute when people are unprepared, are almost never predicted from narrow reliance on the past.

The fact that this notion is not obvious to people is shocking to me. It is particularly shocking that people do what are called “stress tests” by taking the worst possible past deviation as an anchor event to project the worst possible future deviation, not thinking that they would have failed to account for that past deviation had they used the same method on the day before the occurrence of that past anchor event. *

These people have PhDs in economics; some are professors—one of them is the chairman of the Federal Reserve (at the time of writing). Do advanced degrees make people blind to these elementary notions?

Indeed, the Latin poet Lucretius, who did not attend business school, wrote that we consider the biggest objeect of any kind that we have seen in our lives as the largest possible item: et omnia de genere omni / Maxima quae vivit quisque, haec ingentia fingit .

PROBABILITY HAS TO BE SUBJECTIVE †

This raises a problem that is worth probing in some depth. The fact that many researchers do not realize immediately that the Black Swan corresponds mainly to an incomplete map of the world, or that some researchers have to stress this subjective quality (Jochen Runde, for instance, wrote an insightful essay on the Black Swan idea, but one in which he felt he needed to go out of his way to stress its subjective aspect), takes us to the historical problem in the very definition of probability. Historically, there have been many approaches to the philosophy of probability. The notion that two people can have two different views of the world, then express them as different probabilities remained foreign to the research. So it took a while for scientific researchers to accept the non-Asperger notion that different people can, while being rational, assign different probabilities to different future states of the world. This is called “subjective probability.”

Subjective probability was formulated by Frank Plumpton Ramsey in 1925 and Bruno de Finetti in 1937. The take on probability by these two intellectual giants is that it can be represented as a quantification of the degree of belief (you set a number between 0 and 1 that corresponds to the strength of your belief in the occurrence of a given event), subjective to the observer, who expresses it as rationally as he wishes under some constraints. These constraints of consistency in decision making are obvious: you cannot bet there is a 60 percent chance of snow tomorrow and a 50 percent chance that there will be no snow. The agent needs to avoid violating something called the Dutch book constraint: that is, you cannot express your probabilities inconsistently by engaging in a series of bets that lock in a certain loss, for example, by acting as if the probabilities of separable contingencies can add up to more than 100 percent.

There is another difference here, between “true” randomness (say the equivalent of God throwing a die) and randomness that results from what I call epistemic limitations, that is, lack of knowledge. What is called ontological (or ontic) uncertainty, as opposed to epistemic, is the type of randomness where the future is not implied by the past (or not even implied by anything). It is created every minute by the complexity of our actions, which makes the uncertainty much more fundamental than the epistemic one coming from imperfections in knowledge.