Professional Documents
Culture Documents
Stephen Kinsella∗
April 28, 2008
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There is no such thing as absolute certainty, but there is assurance sufficient for the purposes of
human life. We may, and must, assume our opinion to be true for the guidance of our own conduct:
and it is assuming no more when we forbid bad men to pervert society by the propagation of
opinions which we regard as false and pernicious. I answer, that it is assuming very much more.
There is the greatest difference between presuming an opinion to be true, because, with every
opportunity for contesting it, it has not been refuted, and assuming its truth for the purpose of
not permitting its refutation. Complete liberty of contradicting and disproving our opinion, is
the very condition which justifies us in assuming its truth for purposes of action; and on no other
terms can a being with human faculties have any rational assurance of being right.
The consequences of ignoring the existence of Black Swans–—any high impact, low probability event—–
can be disastrous. 9/11 was a Black Swan, the success of the Harry Potter series was a Black Swan, a taxi
driver receiving a 100 dollar tip on a five dollar fare is a Black Swan. These events are rare enough to be
highly improbable, but, coming from a power-law infested world as we do, the events are more common than
the ‘empty suits’ suppose in their Gaussian-driven models. Taleb avers the course of history itself is driven
and directed by Black Swans, and, thanks to globalisation, mass communication, and sheer chance, their
impacts are driving history forward at an unprecedented rate.
In the spirit of announcing the limits to our knowledge, this review is not without its problems. The
Black Swan deliberately defies compression or truncated description, and the ideas lodged within its covers
are deep, and quite scary. Taleb himself is disquieted by them. He writes on page 215:
I have spent my entire life studying randomness, practicing randomness, hating randomness. The
more that time passes, the worse things seem to me, the more scared I get, the more disgusted I
am with Mother Nature.
Therefore any review of this book (and there have been many) will be partial, less a guide or a summary,
and more a smattering of impressions, thoughts, and questions on certain aspects of the book. To the reader
I apologise.
The book begins with Taleb’s story, coming from the Levant, living through a war, cancer, and stock
market crashes. We, the readers, are then given an overview of Taleb’s arguments about scaling and non
scaling distributions, as well as an introduction to the problem of induction, of which a Black Swan is a
symptom. We are told to consider the fate of the turkey. Three days before he is to die, the turkey has
no inkling of his fate, and assumes his fattening will go on forever. To the turkey, his death is a Black
Swan event, given the way he has been treated up to the moment of his death. Taleb urges us not to be
turkeys, and shows us why we continue to behave like them in our daily lives. First, humans are blessed
and cursed with biases which mask the presence of Black Swans. We seek evidence to confirm our opinions,
and once we find that evidence regardless of whether it happens to be the truth, we cling to that evidence
as ‘fact’. We seek simple, linear stories to fit the complex chain of events which has just occurred. We
ignore silent evidence, and choose to believe we live in a nice, safe world—Gaussian-dominated—rather than
the power-law dominated world we actually see. Taleb writes on page xix,“[i]t is easy to see that life is the
cumulative effect of a handful of significant shocks”. There are no outliers—just observations we don’t have
explanations for. The result of these blind spots is a failure to predict with any accuracy over long time
horizons. The ‘expert’, then, becomes just another shaman dancing in the dust, because his science cannot
do much better than prayer in predicting what will happen in complex environments like the macroeconomy.
We are given a snapshot of what to do when we cannot predict, of which more below, and the book closes
with an exhortation not to be a sucker by simply acknowledging the presence of Black Swans, and acting
accordingly. It is your actions which should change in the light of this new knowledge, not your thinking.
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If I were smarter, luckier, or more hard-working, I would be more like Richard Feynman, or Alan Turing,
or Adam Smith. My heroes tell you something about me. Among Nassim Taleb’s heroes are Karl Popper,
G.L.S. Shackle, and Sextus Empiricus. Each hero resonates with a different part of Taleb’s argument.
Karl Popper exposed the crucial problem of induction in a world where the transition from specific
evidence to general claim through a simple causal story is fundamentally flawed. Taleb sums the position
up nicely on page 55: “Alas, with tools and fools, anything can be easy to find. You can take past instances
that corroborate your theories and you treat them as evidence”.
George Lennox Sherman Shackle focused on the role of uncertainty and expectations in economic pro-
cesses, identifying, in some sense, the role of un-knowledge in economics Shackle (1990 [1949], 1972); Koppl
(2001). Shackle’s lesson to Taleb is to ditch the search for general theories of economic behaviour (Taleb,
2007, pg. 185), in favour of some measure of ‘un-knowledge’. Taleb offers us the vision of Paul Samuelson as
knowing only a little mathematics, and this little knowledge, applied in an overly didactic and confident way,
can sway a discipline if the expositor is in the right place (a reputed wunderkind, at MIT, leading textbook
writer, etc, etc).
Sextus Empiricus belonged to a school of thinkers who trained themselves to doubt everything “and thus
attain a level of serenity”(Taleb, 2007, pg. 46). The school believed that any dogma was incorrect, because
any dogma requires belief in a stable system. From Sextus Empiricus, Taleb takes the lesson of relentless
trial and error in the face of unquantifiable uncertainty.
Taleb cites the work of other scholars as well. Taleb dedicates the book to Benoit Mandelbrot, the father
of fractal geometry, and lionises Algazel, Bastiat, Bayle, and to a lesser extent, Hume ((Taleb, 2007, pgs.
43-50)). So Taleb is in good company for his exploration of effects of uncertainty on normal life.
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plans by large organisations like governments—they can only be incorrect.
One issue Taleb does not explore is what would happen if everyone took his advice. In a world of Talebs,
all aware on a genetic level of the fact that absence of evidence is not evidence of absence, conscious of their
ignorance and open to any opportunity, the effects of Black Swans would likely be increased rather than
decreased on society.
Consider the following simple model of income determination with uncertainty built into it, and the role
of the Black-Swan aware population becomes clear. The Black Swan economy, let us call it, is created from
a randomly generated population of agents indexed by i = 1, . . . , n. Each of these agents is endowed with a
normally distributed level of resources, RES, opportunities, OPP, and abilities, ABIL, creating a human capital
index of the population of agents in the first period of the model as follows:
n
!
Hit = (Oppit + RESit + ABILit ). (1)
i=1
The initial distribution of the level of human capital in the system looks Gaussian, as figure 1 shows.
Let’s endow the agents with power-law like reserves of some value-holding good we’ll call capital, so some
are very rich, and some are very poor. The distribution of capital, K, in the economy initially looks like
figure 2 below.
Now let’s allow the agents to take advantage of their luck in a labour market, where they contract for
services next period with a firm who hires them with reservation wage ri , where for each agent i, ri ≥ Hit .
If they make a deal with the firm to their advantage, households save the difference, and this adds to their
wealth. If they don’t make a deal, agents receive a ‘dole’ of 0.1 × (ri ).
If we iterate this simple model over 100 periods, a log normal distribution of wealth emerges with exponent
α = 0.8 3 , as we can see below from figure 3, and our simulation can start. This simple model is set up,
deriving much inspiration from Champernowne (1998).
Let’s allow our agents now to experience Black Swans. Let them set their expectations on income in
the next period based on their incomes received in the past, so Hi,t+1 = Hi,t , though they may be way off,
especially if their reservation wage is much greater than the dole they receive while unemployed. Households
3 Mathematica code for this simulation is available from the author at stephen.kinsella@ul.ie.
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K
3.5
3
2.5
2
1.5
1
Households
20 40 60 80 100
% Wealth
0.3
0.25
0.2
0.15
# Households
20 40 60 80 100
Figure 3: Evolution of wealth distribution after 100 periods.
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can save what they have earned, hedging away against uncertainty, or not. Those that save a lot, because they
know the world is uncertain, I’ll call Black Swan households. Other households we can call ’Turkeys’. Now
firms can begin making erratic, essentially random, wage decisions, from period to period, creating ‘turkey’
households. The households in the system must now deal with the consequences of misplaced expectations,
in periods going forward. Some households are turkeys, others are not. The dispersion of income increases
by a factor of nine in my little simulation. So, even though some households do better (they happen to be
driving the cab Nassim Taleb is sitting in, and receive the 100 dollar tip), most do not, whether they are
aware of the presence of uncertainty or not.
This is why we have the institution of insurance and reinsurance, because, as (Shaw, 1956, pg. 1527) put
it “A bookmaker who gambles will ruin himself as certainly as a [bartender] who drinks”.
4 Perspective matters
Say you own a car. You wish to drive the car down a road through a ‘T’ junction like the one shown in
figure 4 below. The problem is to drive out onto the road without being hit by an oncoming car. The cars
drive on the right. For the most part, you can see the road to the left and right. This is a winding road
however, and there can be a car in the knees of the curves either side at any moment. So, while most cars
coming towards the driver are observable, some are not.
There is a probability distribution around the numbers of cars the driver sat at the T junction might
see, were they to sit there for a few days, stopping traffic behind them. From the perspective of an overhead
helicopter with all day to wait, the solution is simple. But our driver cannot wait, and cannot see, and is their
problem. The problem is a simple stochastic one, unless one is the unfortunate driver there and then on the
road. The driver must drive out now, and in doing so, they take the chance of being hit while invalidating the
probabilistic argument for staying put. Taleb and Mandebrot call this the problem preasymptotic4 —because
4 See http://www.fooledbyrandomness.com/preasymptotics.htm.
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Figure 4: Faced with oncoming traffic he can’t see from the left, what is our driver to do?
we live now, not in the limit, many of the central predictions of modern statistics fail us, as (Shackle, 1990
[1949], pg. 7) would attest. So as far as repeated trials of a fixed system go, probability theory is mostly
useless to the driver—conditions are changing, and they do not have repeated chances to turn right, they
must turn right now. Taleb’s argument in the Black Swan is to be aware of the knee in the bend and, as
much as possible, make sure to try and avoid being hit by someone traveling at speed through that bend
at the moment the driver turns right. The driver following this advice would therefore edge very slowly
forward, trying to see whether a car is coming. This shows they recognise the danger of their situation.
But, as Mill shows us, we must act, and so, in spurting forward, our driver takes their life into their hands,
and all the awareness in the world means nothing for them beyond this point. But, by taking the time to
look both ways and edge out slowly—avoiding unnecessary reliance on long range predictions (for example,
“there’s never anybody on that road after 7pm”)—the driver might be made a little safer. They might still
get squashed.
The regulation school solution to this problem is traffic lights at the intersection but, when those do not
exist, or work incorrectly, the problem of getting squashed remains.
Taleb’s arguments (given on pages 201–208) are more varied than this caricature might lead the reader
to believe, however, the book does not address the central issue of what to do when we cannot predict with
any accuracy. Be human; be humble regarding the quality of your knowledge; be open to every opportunity.
These recommendations might help us stop the Brooklyn Bridge from wobbling, but I doubt they will stop
the financial system from collapsing again in five years’ time, or stop ‘experts’ from attempting to predict
the future.
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against. A story must be told, so they tell it. If every expert came with a warning sign strapped around
his or her waist like cigarette packets, Taleb would not be happy. Their arrogance, he claims, leads them
to oversell the linear story, and damn the future by leaving it more and more at the mercy of Black Swans.
For economists, where we study a domain where long term plans are useless (like the macroeconomy), we
should start planning for events we can’t control. Such planning is hard, and very counter intuitive. Taleb,
as a story teller, cannot be against that. What he is against is practioners taking the words of the experts
as gospel, and harming themselves and society as a consequence.
The Black Swan is a starting point toward a more general understanding of the role of uncertainty in
human affairs which, while imperfect, has created a debate around the nature of forecasting in unpredictable
environments like the macroeconomy and the stock market, and for that Nassim Taleb is to be thanked.
References
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