Monday, August 20, 2007

The Black Swan

Update on November 2011 
Taleb has this tendency to ramble on and to show off. if you can put up with these, his books are very interesting and there is enough take away for the reader. I would however recommend 'Fooled by Randomness' if  some one points a gun at you asks you to choose only one :-). Since most  don't have to go through such a predicament,  i would recommend both.

I am reading this book called "The Black Swan" by Nassim Taleb. He is also the author of Fooled by Randomness, another book in my shelf, to be read.

This book starts with the interesting story about swans. All swans were thought to be white for a long time. Then someone sighted a black swan in Australia. That invalidated the theory/understanding that all swans are white. The author quotes this event and mentions that this illustrates a severe limitation to our learning from observations or experience and the fragility of our knowledge.

He defines a black swan as an event with the following three attributes
  • First, it is an outlier (a statistical observation that is markedly different in value from the others of the sample) as it lies outside the realm of regular expectation, because nothing in the past can convincingly point to its possibility
  • Second, it carries an extreme impact
  • Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.
A black swan is defined by Rarity, Extreme Impact and Retrospective predictability.
Examples of black swans are rise of Hitler and subsequent war, precipitous demise of Soviet bloc, rise of Islamic fundamentalism, spread of internet, market crash of 1987 and subsequent recovery.

The author says that more surprising than the occurrence of black swan is our own belief that it doesn't exist. He says that our blindness with respect to randomness, particularly large variation, is alarming. He adds that the black swan logic makes what we don't know far more relevant than what we know. He cites the example of 9/11 and adds that in a 9/11 kind of strategic game, what we know is truly inconsequential.

The author says that black swans being unpredictable, we need to adjust to their existence and mentions the concept of anti-knowledge, explained later in the book. The author also complains that we tend to focus excessively on what we do know, we tend to learn the precise, not the general . His point is that we have lost the ability to learn the meta-rule or the abstract of any problem. This is because we are kept reminded that it is important for us to be practical and take tangible steps rather than 'theorize' about knowledge. The author claims that we scorn the abstract with a passion.

To summarize, the author claims that our world is dominated by the extreme, the unknown, and the very improbable – and all the while we spend our time engaged in small talk, focusing on the known and the repeated. We have to change ourselves to treat the extreme event as norm and not the exception. He also says that in spite of much progress and growth in our knowledge, the future is going to be less predictable. The basic message is that most important things in the real world do not follow anything like a normal distribution.This book is very interesting because i believe this will throw lot of light on how risks should be managed.

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