The Black Swan, by Nassim Nicholas Taleb

>> Friday, August 14, 2009

TITLE: The Black Swan
AUTHOR: Nassim Nicholas Taleb

COPYRIGHT: 2007
PAGES: 310
PUBLISHER: Penguin

SETTING: N/A
TYPE: Non Fiction, epistemology, I suppose
SERIES: Not really, although it's related to another of NNT's books, Fooled by Randomness.

REASON FOR READING: Buzz.

The subtitle of The Black Swan is: The Impact of the Highly Improbable, and that pretty much describes what it's about. It would take pages to accurately convey all that's in the book, but briefly, what Taleb calls black swans are events with the following characteristics: a) before they happened, they were considered to be extremely unlikely (either that, or were simply unimaginable), b) they have an extreme impact, and c) after the fact, we tend to theorise about how they actually were quite obvious and predictable. Think stuff as disparate as the current financial crisis, the invention of the internet, the attacks of Sept. 11th, or the success of the Harry Potter books.

The problem is, we behave as if these black swans didn't exist, as if we could predict more or less what's going to happen and as if the world always followed a normal distribution. Taleb argues that in some areas we can, but in others, the world just doesn't behave that way at all. To illustrate he distinguishes between what he calls Extremistan and Mediocristan.

Say you have a group of 100 people and you want to calculate their average height and wealth. You measure everyone and ask them what their wealth is and you make your calculations. You get an average height of 1.69 m (about 5 ft 7 in) and an average wealth of £104K (we're assuming these are British people in 2007, since that's the data I could find!). But after you're finished and the participants are all gone, you realise that you missed one individual in the group. Should you go running after him or her to get your data, or can you assume that missing one person won't have much of an effect?

Let's consider height. Even if the person you missed was the tallest person ever (that would be Robert Wadlow, at 2.74 m -some 8 ft 11 in), including him in your calculations would only add 1 cm (or 0.4 of an inch) to your average height. Not worth bothering chasing him for that, surely. You can be very sure that even missing one person, the average height of your group of people would still be 1.69ish.

Height, Taleb would argue, is from Mediocristan. As long as you have enough other instances to average it out, one observation, however extreme, won't have an undue effect on the average.

Is it the same with wealth? If the person you missed was, say, a certain guy called Lakshmi Mittal, who at the time had £19.25 billion, then including him in your average wealth calculations would change your result from £104 thousand to a whopping £193 million. Definitely worth chasing this missing person, then, since without his wealth data you can't be at all sure that that your average won't be utterly and completely wrong.

Wealth, then, is from Extremistan. One observation here can have devastating effects on the average, if it's extreme enough, even if you have a lot of observations.

The problem is, according to Taleb, that we're really, really bad at deciding when something belongs to Mediocristan or to Extremistan, or even at realising that Extremistan exists at all. A lot of us just seem to behave when we're in Extremistan as if we were in Mediocristan, especially when we are investing, not realising that we're putting ourselves in a position when one bad day can completely wipe us out. We don't realise that in Extremistan, there's no completely reliable way of knowing what will happen, because predicting based on the past (say, oh, that house prices will continue rising, because they have been rising for the past 10 years) takes no account of the fact that a black swan might just show up in the horizon.

Most of the book explores why we have these penchant for obliviously convincing ourselves we're still in Mediocristan, and how we might deal with this. It's a bit short on practical advice, so you'll probably close the book quite a bit more worried than you started it, but it's fascinating, eye-opening stuff.

It's also extremely readable and entertaining. A review I read called it "a cross between a popularisation and a diatribe", and that's a pretty accurate description. Taleb is great, he's arrogant to the point of obnoxiousness, but you get the feeling that he's got enough intelligence to be as arrogant about it as he bloody well wants to be.

MY GRADE: An A.

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