All entries for Saturday 14 November 2009

November 14, 2009

Review: The Black Swan

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I'd like to invite my readers to perform an amusing experiment. First, search the web for a page outlining the causes of the current financial crisis (I recommend the Wikipedia article on the matter), and skim through the sections to get an idea of how many different events could supposedly have been used as indicators of the upcoming disaster. Then, perform a new search, to find out how many experts saw it coming and how early they predicted it.

You should find a puzzling contrast between the two.

'The Black Swan' by Nassim Nicholas Taleb is not a book about the global recession. In fact, it was first published in 2007 and does not even attempt to make any economic forecasts whatsoever. Still, the book bears a relation to the crises, as it is about the unpredictability in general. According to Taleb, the more significant events of human history, the ones that have the most impact, are not following a traditional cause-effect structure, but are intrinsically unpredictable events which He calls these events 'Black Swans' -- a reference to the unexpected discovery of the non-white swans -- and describes them as having the following three characteristics: Rarity, extreme impact, and restrospective (though not prospective) predictability.

First, it is an outlier, as it lies outside the realm of regular expectations, 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.
Just imagine how little your understanding of the world on the eve of the events of 1914 would have helped you guess what was to happen next (Don't cheat by using the explanations drilled into your cranium by your dull high school teacher.) How about the rise of Hitler and the subsequent war? How about the precipitous demise of the Soviet Bloc? How about the rise of Islamic fundamentalism? How about the spread of the Internet? How about the market crash of 1987 (and the more unexpected recovery)? Fads, epidemics, fashion, ideas, the emergence of art genres and schools. All follow these Black Swan dynamics. Literally, just about everything of significance around you might qualify.

Taleb then goes on to describe two hypothetical worlds, Mediocristan and Extremistan. The former is a place where the common is the rule and where anything out of the ordinary is so insignificant that it can be ignored, while the latter is the exact opposite, a place where the highly improbable can have an massive impact, i.e. a place where Black Swans occur. In our world some things do belong to Mediocristan, like the height distribution of people ("extreme" cases have little to no effect on the global average), but a lot of other phenomena belong to Extremistan, like book sales (a few bestsellers can completely outweigh the enormous mass of lesser-known books) and often we don't realise it. Taleb uses these concepts to segue into various other related topics, such as the problem of induction, the flawed notion of an 'expert', empirical skepticism, and even the 80/20 rule and the Long Tail, which I wrote about in this post.

The style of the book is rather singular in my opinion. The book content is quite serious and displays profound insights and deeply held opinions of the author, and yet it is written in an entertaining and casual way. It is full of sophisticated expressions ("Epistemic arrogance", "Platonic fold") and references to well-known thinkers (David Hume, Karl Popper, Henri Poincaré, etc.), and yet in the same time it contains a lot of informal language, blatant sarcasm and cynicism, as well as several Yogi Berra quotes. If we set aside the actual content for the moment, I'd say it's definitely an enjoyable reading experience for anyone.

It is, however, the content that matters in a book like this. I personally found myself pleasantly agreeing with the author half of the time, and strongly disagreeing with him the other half. Taleb has a strong dislike for academics (due to their tendency to allegedly think inside the box and ignore unpredictable Black Swans), whereas to me the Academia is one of the most respectable and honest communities there is -- so there's already one point on which we don't see eye to eye. Furthermore I like to think that the world in which we live is predictable to some extent, and that through continuous effort and research it may be possible to construct more realistic models of reality,so 'The Black Swan' goes against much of what I believe in. But as Taleb says himself, you learn more by reading authors with whom you disagree. Taleb himself is very well-read, a fact which pervades the book, so while it is true that much of what he presents is his personal opinion, he has some strong evidence on his side and presents convincing arguments for his case. I also enjoy his bashing of macroeconomic theory and his criticism of financial experts and economic forecasters, not to mention his depiction of bankers, statisticians, and other people who pretend to be mathematicians. Finally, I am totally awed by the fact that he knows Benoît Mandelbrot personally.

I read 'The Black Swan' in the way I believe Taleb would have wanted me to: skeptically, and with an open mind. I do not blindly accept every word of his book, and still disagree with him on certain areas. But I have definitely learnt something from his book. I now see the world in a slightly different perspective, as I am sure anyone taking his book seriously would. If you are a firm believer in the predictability of historical events or in the principles of modern financial theory, I cannot promise that you will like what Nassim Nicholas Taleb has to say. That, however, doesn't stop me from recommending the book, especially if you are one of those people.

Other similar books include 'The (Mis)behaviour of Markets' by Mandelbrot, or 'Fooled by Randomness', Taleb's previous book.

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