Errors in the Interpretation of the Black Swan philosophy
“Summary of the problem discussed in The Black Swan (and associated papers): The problem, basically stated (which I have had to repeat continuously) is about the degradation of knowledge when it comes to rare events (”tail events”), with serious consequences in some domains I call “Extremistan” (where these events play a huge role, manifested by the disproportionate role of seven single observation, event, or element, in the aggregate properties). I hold that this is a severe and consequential statistical and epistemological problem as they cannot assess the degree of knowledge that allows us to gauge the severity of the estimation errors. Alas, nobody has examined this problem in the history of thought, let alone try to start classifying decision-making and robustness under various types of ignorance and the setting of boundaries of statistical and empirical knowledge.
The point of The Black Swan is that both empirical knowledge (i.e. extrapolating statistics) and a priori theories fail in the tails and it is vital to “robustify” against it using the concepts of “the fourth quadrant”. The point has been garbled by members of the economics establishment that claim mistakenly “we know that” and “we know about fat tails” or “power laws”. This is both wrong and not my point. The paper presents corrections to the misperceptions.”
(Excerpt Common Errors in the Interpretation of the Ideas of The Black Swan and Associated Papers by Nassim Nicholas Taleb; source SSRN)
A more compact summary: theories fail most in the tails; some domains are more vulnerable to tail events.
Furthermore, to be more aggressive, while limits like those attributed to Gödel bear massive philosophical consequences, but they can’t do much about them, I believe that the limits to empirical and statistical knowledge I have shown have both practical (if not vital) importance and they can do a lot with them in terms of solutions, with the “fourth quadrant approach”, by ranking decisions based on the severity of the potential estimation error of the pair probability times consequence (Taleb, 2009; Makridakis and Taleb, 2009; Blyth, 2010, this issue).
Key Mistakes Made While Interpreting Black Swans (excerpted via SSRN):
1. It is not quite about the Gaussian distribution
2. There’s no such thing as a historical event in the probabilistic sense
3. Folk Psychology, & Philosophy of Probability
4. The problem of induction, causation, and complexity
For those who want to read the article I’ve been so kind to provide it here through Scribd. The original source is SSRN.
Nassim Taleb: On Errors in the Interpretation of The Black Swan
Filed under: Life, the Universe and Everything, Nassim Taleb, The Black Swan
A historical testimony to the US congress! Or is it?!
Can you recall a moment when you could honestly say ‘I told you so’, but when no one listens? Well this just might be one of those for me.
This Thursday September the 10th marks perhaps a historic development for both Washington and the financial markets. The US Congress’ Committee on Science and Technology held a hearing on the responsibility of mathematical model Value at Risk for the credit crisis.
Nassim Taleb has been invited as expert witness by the Committee. Being a real derivatives trader for decades, Taleb has been warning about VaR’s potential for destruction for at least 13 years.
Read the official Report on The Risks of Financial Modeling, VaR and the Economic Breakdown by Dr. Nassim N. Taleb here.
While Taleb was kicking ass in the US capital, I would like to contribute to the crusade by illuminating some insights from the now famous book The Black Swan.
For those mortal bipedal, carbon-based humanoid lifeforms with any significant level of complexity in their neo-cortical pathways who didn’t realize; ‘The Black Swan’ is not just another book. It in fact is a compilation of empirically valid phychological and logically coherent philosophical insights into the human mind and behavior, including the world around us, in which some thoughtful guy warns us for our ‘intellectuall arrogance’ and predisposed incompetence to harness the consequences of randomness in life, or any social situation for that matter.
This he eloquently calls ‘The Black Swans’, which is a technical name for the problem of induction in philosophy of science, especially social sciences that is.
I’ve always hoped, but never thought, that Nassim Taleb would get to be heard by the US congress. Is he just casting ‘pearls to swines’ here (as some guy called Jesus once said it) or is he really being heard?
Taleb, after 13 years of fighting against complex derivatives and bogus quantitative risk management, finally got his say in congress last week on 10-09-2009. In this video compilation you can see a few of the points he made there.
Nassim Taleb testifies before Congress, under oath, and uses his insights in errors conducted by humans in complex systems, like the financial markets, to warn against mishandling of these errors and the (im)morality of deficit spending and the culture of incentivizing failures with bonuses.
In short, the man gives his view on the current financial and economic crisis.
In addition, he also warns of the risks of hyperinflation and presents his technical work on the concept of ‘too big to fail’ (also discussed earlier here) which is directly applicable to the comtemporary banking and monetary systems. Taleb also refers to his previous articles, also discussed on this website, concerning the ever growig complexity in the world, economic ‘charlatanism’ and how to identify the situations that are inherently unpredictable. He also discusses his “Fourth Quadrant” of risks society should not bear because we cannot measure them.
For the technical appendix of the latter concerning Taleb’s article called “The Forth Quadrant” look here.
Taleb also opens a, not so suprising, frontal attack at the ‘Value at Risk’ (VaR) method. Value at Risk are the risk measuments methods used by Wall Street to hide risks and collect bonuses, and are, by the way, still taught at business schools accross the world albeit out of mere ignorance or paradigmati intellectual arrogance.
Although I didn’t compile the video, I would guess that these are just some of the rhetorical highlights needed to give an impression of his testimony to the congress about the financial markets and the contemporary economic situation the US, and the world. Surely, more is to follow so stay tuned.
- To know more about the congress testimony read also the article at Huffington Post: Obama Should Stop by Taleb’s Historic Congress Testimony
- To learn more on Nassim Taleb’s conceptualization of the world watch the follwing video LEARNING TO EXPECT THE UNEXPECTED
Filed under: Featured, Financial Crisis, Nassim Taleb, The Black Swan
Taleb Bets on Hyperinflation, or even Deflation
Universa Investments LP, the hedge-fund advised by “Black Swan” author Nassim Taleb, has a new strategy where they’re betting that the massive stimulus efforts of global governments will lead to hyperinflation. The governments pumping money into the economy cannot prevent hyperinflation, and in the loger run will lead to deflation as well . The strategy has also been reported by the Wall Street Journal and Bloomberg this week.
Universa manages $ 6 billion of funds with Wallstreet ‘hotshot’ Mark Spitznagel as the CEO who, together with co-investor and buddy from Wall Street Taleb, bets on extreme market moves and severe inflation. The hedgefund investing strategy is simply based on the principle that nobody knows where inflation is headed, certainly not those who think they do…
“Policy makers have no control over the outcome of their actions,” Taleb said. “The plane they are flying will either hit the mountain, which is hyperinflation, or crash in the ocean, which is deflation. There is a chance of the pilot hitting the runway. But if he’s not skilled, it’s less than he thinks.”
Universa’s strategy is based on the purchase of deep out-of-the-money options; call and put-options. These are options where the price is lower or higher than the market price of the underlying security. A put option gives the buyer the right to sell a security at a set date (with the intrinsic value as the maximum) and a call option gives the right to buy a warranty.
Universa’s funds doubled returns
Taleb, as the founder of the New York hedge fund, Empirica LLC, spent six years, before closing in 2004, to build a strategy based protecting investors against declines in the market, while profiting from the extreme fluctiations at the same time. Some funds of Universa more than doubled since the bankruptcy of Lehman Brothers Holdings Inc. and the following collapse of the financial markets.
He wrote in “The Black Swan: The Impact of highly improbable”, that history is studded with rare, high impact events. “The options are not as expensive as they should be,” Taleb said, “because the market is not focusing on ” significant events.”
Universa’s CEO and Wallstreet ‘hotshot’ Spitznagel runs the Black Swan Protection Protocol, which buys puts and calls on a portfolio of stocks and the S&P 500 Index Futures. Universa’s portfolio is overseen by Taleb and Spitznagel.
Nassim on CNBC talking about hyperinflation
For further discussion read also the insights of Nouriel Roubini on this matter, who together with Taleb also predicted the current financial crisis.
Nouriel Roubini is also a professor at the Stern Business School at New York University and chairman of Roubini Global Economics, and a weekly columnist for Forbes.
Filed under: Financial Crisis, Nassim Taleb
Taleb @ Zeitgeist Europe ‘09
Staying the Course: Part II – Zeitgeist Europe ‘09
The panel explores those improbable events that the marketplace under-assesses but which end having a powerful and unanticipated influence for investors.
Taleb author of brilliant book The Black Swan says “the more you study economics the less competent you’re going to be…. the past is not similar to the present.. we’re in something we’ve never seen before”.
“Forecasting is futile, being prepared is worthwhile”.
He also says the nation state is irrelevant in the time of Google, get rid of nation governments.
Bremmer talks about how local and state issues are a bigger concern to people than ever.. they don’t care about the rest of the world now.
- Nassim Taleb – Author, ‘The Black Swan’
- Ian Bremmer – Founder, Eurasia Group
Fireside chat: Moderated by Chystia Freeland – U.S. Managing Editor, Financial Times
Filed under: Financial Crisis, Nassim Taleb
Black Swans, complexity, financial collapse etc.
A very thoughfull guy, John Petersen, looks into the future and explains what our societies are facing with the current transformations onset by the evergrowing complexity in the world. Being a remarkably diverse fellow, Petersen elaborates further on the widely misunderstood impact of what Nassim Nicholas Taleb calls ‘The Black Swans’ and gives some other examples on the nature of the complexity mentioned before by i.e. philosopher John Key and mathematician Benoit Manderbrot, to explain why some unprecedented things are afoot. John Petersen, a futurist and the president of the Arlingtion Institute, reinforces his talk with some very interesting statistics worth our consideration, i.e. “The world population has grown more in the last 50 years than in the 4 million years that preceded it”, and the notion that within 20 India years will probably grow to become the most important country in the world… He also talks about the oil production peaks and the importance of harnessing new energy sources.
In short, a very intelligent and thoughtfull lecture on the socio-economic situation of the world today that pust things into perspective and what may be ahead of us.
Here’s the YouTube description and below it the whole playlist of the lecture:
Very thoughtful analysts and theoreticians are now suggesting that we are at the beginning of a full-scale meltdown of the world’s financial system – not just a recession. Nassim Nicholas Taleb, extraordinary investor and author of The Black Swan, and mathematician Benoit Mandelbrot now believe that this financial failure has the potential to be the most significant event since the American Revolution. Couple that with a rapid shift in the planet’s climate system, rising food prices, and a reorganization of the world’s energy regime, and one has the makings of an historical shift in the way we all live that is unlike anything anyone alive has ever considered or experienced. At the same time, extraordinary breakthroughs in science and technology promise that much of what we find familiar will soon be obsolete and give themselves up to amazing new capabilities that seemed like science fiction only a handful of years ago. We are in the beginning of an epochal shift that will ultimately produce not only a new world, but also new humans that have a new set of values and perspectives. Leading world futurist John Petersen explores not only what is happening and might happen – but also what might come out of it all.
Filed under: Collapse of Society, Financial Crisis, Life, the Universe and Everything, Nassim Taleb, Video
Let’s face it; Economists are charlatans!
At the New Yorker summit Robert Shiller and Nassim Taleb discuss what to do in such times when the spirits aren’t brave at all.
Shiller, a Yale economist who famously predicted the last two booms also wrote a book called “Animal Spirits in which he posits that shifts in the economy follow the irrational actions of people. Analagous to Taleb, only with a different emphasis. Shiller also notes that his work was seen as “flaky” by other macroeconomists as he was, most likely, replaced as a professor of economics at Yale by Timothy Garthner’s administration for not agreeing with them… He basically says that everyone got too obsessed with data and that economics got too “scientific.”
Taleb, who needs no further introduction on this website, except of being a bottom-up practitioner, essayist, options trader, philosopher and also a professor of Risk Engineering at N.Y.U., and at the Wharton School; says the economy is not scientific at all. “Economics made astrology look excellent” as a science, and he compares the discipline to 19th century medicine where going to a doctor increased your chance of death because they believed in i.e. bleeding etc. In other words, people trusted these experts not knowing that their theories where bogus and based on unscientific assumptions. The same is the problem with economic experts nowadays.
They both do agree, it’s only that Taleb dares to take a more radical point of view concerning what the solution is. But nevertheless, I’m not sure that Schiller completely understands where Taleb is coming from eventhough he does agree with him on the reasons that got us here. But hey, Schiller is a top-down economic expert while Taleb (also being one using the academic jargon but in exactly the opposite way), having the luxury of having several 0’s more on his bank account, is deliberately provoking the whole economic establishment by calling them ‘academic frauds’. And rightly so, if you ask me.
So Taleb provides his non-expert advice, which is often misinterpreted: “We need to get rid of the “experts” who didn’t see the crisis coming!” — even a cabdriver, he says, can see the problem that Bernanke didn’t.
They both also agree that debt is destabilizing, and we need to reconceptualize how we treat and use it. Taleb suggests turning all debt to equity—the dot.com equity bubble resulted in worthless stocks, but didn’t leave us all indebted. He suggests we could do the same with housing.
Taleb notes that globalisation and the Internet have made the nature of debt different (including our societies) as a run on the bank can take seconds, or as one can bankrupt Iceland with a BlackBerry… Everyone who has read his book ‘The Black Swan’ knows where he’s heading, namely that all these phenomena are inevitably contributing to an evergrowing complexity in our society. Therefore, we need to be way more cautious when making predictions, especially in the financial markets but generally in every social situation.
“I don’t know what better regulation means,” Taleb says, after Shiller dismisses his claim that regulators don’t work. Taleb calls Shiller a “top-down economist” and refers to himself as a “bottom-up libertarian.”
Shiller defends regulators, and Taleb says they are easy to dupe and asks, “Do you know any intelligent people who became regulators?” Shiller defends them again; says he’s met smart regulators.
Taleb worries that Bernanke will make the problem worse and cause massive inflation. “Someone who crashes a plane, you don’t give them a new plane!”
Shiller amusingly ends with: “I don’t usually end up debating him!”
Here’s the video:
P.S. Also take note of this guy, Malcom Gladwell, who once more emphasizes that we have an ‘illusion of control’ contributing to unsound overconfidence in experts…a point made by Taleb a while ago.
Filed under: Financial Crisis, Nassim Taleb
Complex systems, the economy and experts…
After all, we are witnessing the Waterloo of Wall Street. So, ironically, it was in the Canadian province of Ontario, in the small town of Waterloo, that a meeting was convened to shed new light on the world’s financial debacle. In a densely packed conference schedule, the general approach was to take measure of the crisis not only in a new way, but with instruments never used before. Even the venue for event, the Perimeter Institute for Theoretical Physics, was itself programmatic, though invitations to participate were sent far beyond the boundaries of economics and physics to mathematicians, lawyers, behavioral economists, risk managers, evolutionary biologists, complexity theorists and computer scientists.
THE ECONOMIC MANHATTAN PROJECT — THE VIDEOS
Introduction
In December, Edge published “Can Science Help Solve the Economic Crisis?” by Mike Brown, Stuart Kauffman, Zoe-Vonna Palmrose, and Lee Smolin. The paper was prompted by a suggestion by Eric Weinstein for an “Economic Manhattan Project”.
This led to the Perimeter Institute conference: “The Economic Crisis and its Implications for The Science of Economics”. According to the organizers, “Concerns over the current financial situation are giving rise to a need to evaluate the very mathematics that underpins economics as a predictive and descriptive science. A growing desire to examine economics through the lens of diverse scientific methodologies — including physics and complex systems — is making way to a meeting of leading economists and theorists of finance together with physicists, mathematicians, biologists and computer scientists in an effort to evaluate current theories of markets and identify key issues that can motivate new directions for research.”
Eric Weinstein Nouriel Roubini Richard Freeman Nassim Taleb at Perimeter
The conference began on May 1st, with a day of invited talks by leading experts to a public audience on the status of economic and financial theory in light of the crisis. I was pleased to be invited and to listen to the first day of public talks.
Among those participating were Nouriel Roubini, Nassim Taleb, Emanuel Derman, Andrew Lo, Richard Alexander, Eric Weinstein, introduced by Theoretical Physicist Neil Turok, who recently moved Cambridge to become the Executive Director of Perimeter, and Lee Smolin, a founding member and research physicist. Doyne Farmer of the Santa Fe Institute, and one of the original Edge contributors, was also in attendance.
Nassim Taleb at Perimeter: there’s too much in the fourth quadrant to clean up.
Eric Weinstein set the stage with a statement on his talk, which began the proceedings:
An unexpected economic crisis provides an excellent opportunity to better understand the state of Economic theory as a science. While there appears to have been a broad systemic failure within the community of professional economists to predict the current collapse, it must be noted that there have been scattered successes which appear striking and demand our attention. The goal of this conference is to bring together economists, biologists, mathematicians, physicists, programmers, and financial professionals to explore the opportunities for bringing economic theory into closer contact with the more traditional sciences as the basis for ongoing work, partnership, and collaboration. Eric Weinstein: Success is not an option
Jordan Mejias, arts correspondent for Frankfurter Allgemeine Zeitung and frequent Edge contributor, attended as well. His interesting report ran on the front page of the FAZ Feuilleton.
I am pleased to present the video presentations of Eric Weinstein; Nouriel Roubini; Nassim Taleb, a panel discussion of Eric Weinstein, Nouriel Roubini, Richard Freeman, and Nassim Taleb; Emanuel Derman, Andrew Lo, Richard Alexander; a panel discussion of Emanuel Derman, Andrew Lo, Richard Alexander, Bill Janeway, Zoe-Vonna Palmrose; and Doyne Farmer.
[This article appeared on Edge.org website and the author and/or the publisher are to be credited explicitly for the content. Alphaverse.com is not affiliated in any way with the publisher of this article. Alphaverse.com uses this material purely for educational purposes.]
Filed under: Edge.org, Nassim Taleb
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