Monday, September 3, 2012

The Black Swan

The Black Swan ... "Well, That's Life...
The late, great Polish journalist, Ryszard Kapuscinski, wrote in his book on the last days of the Soviet Union, Imperium - that the genius of the Russian people can be summed up in their oft-repeated phrase, "Well, that's life!".A young boy finds that his hometown is no longer a part of Poland but is, instead, a part of the Soviet Union due to the extremely improbable (and brief) courtship between Hitler and Stalin. Well, that's life! Shortly thereafter, that same boy finds many of his friends and neighbors being carted off on trains to Siberia by the NKVD (the forerunner to the KGB) for no apparent reason. Well, that's life!

On some perverse whim, Stalin decides to (literally) starve ten million Ukrainian peasants -- almost a third of the population to death.  At the death/work colony of Kolyma , a place that gave birth to another phrase of relativist consolation, "Don't despair, it was worse in Kolyma!" -- Beria's henchmen gave their victims the 'choice' between dying of hunger, hard labor, sleep deprivation, disease, sadism, hopeless despair, (literal) freezing, and, for the fortunate few, being shot. Well, that's life!
Ryszard Kapuscinski
All of a sudden, the mighty Soviet Union  which had terrorized, humiliated, enslaved, and froze people to death  collapses and disappears from the maps ... its red tzars going the way of the tzars of old. Just as unexpectedly, there are new nations and quasi-nations that arise out of the Imperium that virtually no one -- including the people who are part of these would-be nations  had known had existed. Well, that's life!

The genius of Nassim Nicholas Taleb - on masterful display in his new book, The Black Swan: The Impact of the Highly Improbable - is that he has managed to capture what Kapuscinski calls the "essence of truth," as represented by the aphorism "Well, that's life!", in an even more succinct (but no less scientific) concept/turn-of-phrase: "The Black Swan."

The Black Swan, the book, is the most important book in social science since Adam Smith's The Wealth of Nations
. Nassim Taleb's book also happens to be the most significant contribution to the science and philosophy of uncertainty since Andrey Kolmogorov axiomitized probability theory (which along with Bayes, gave us the solid foundation necessary to think clearly about chance) and made progress (with contributions by Chaitin and Solomonoff) towards a more mathematically precise definition of randomness. In terms of epistemology, reading The Black Swan gave me a sense of intellectual kinship that I have not felt since reading Isaiah Berlin's "The Hedgehog and the Fox".Nassim Taleb is a  modern philosopher of randomness and a philosopher who praises erudition above all.Nassim is also a top Financial Math expert, philosopher, statistician and a Hedge fund manager,a guy who uses philosophy in decision making,model building and hedging the funds.He made the theory of Black Swans , the rare events that are massive in impact

"Amen," Platonicity, and 'The Little Prince'

I am slightly embarrassed, but not too embarrassed, to admit that reading The Black Swan was an almost quasi-religious experience, full of sublime epiphanies. There were parts of this book where I found myself muttering "amen" -- in the fashion of many in the plebeian parts of Protestantism -- in delighted agreement with the sentiments of its author. (I don't know whether the Reverend Thomas Bayes ever generated an amen from his congregation, but I'm sure he would have given a hearty amen to Nassim Nicholas Taleb.)

All of this genuine enthusiasm is despite the fact that I was expecting to be slightly disappointed by the latest book. After reading his previous book, Fooled By Randomness, I had the impression that Taleb's next book, which became The Black Swan, would be a book that would be geared toward a more technical audience and would be something akin to an anthology of NNT's more formal writings with a sprinkling of more accessible material. Instead, The Black Swan, the book, that we have before us is targeted toward more-or-less the same audience as Fooled By Randomness had, and follows a similar format and tone. But this superficial similarity is (unintentionally) deceptive.
Nassim Taleb runs his Business Empirica Capital that does not deal with stocks and bonds it deals with trade options.Nassim is called by many as the "Modern Nietzsche" or even "Modern Renaissance Man"

Nassim has stated that his major hobby is "teasing people who take themselves and the quality of their knowledge too seriously and those who don't have the guts to sometimes say: 'I don’t know ...'

The Black Swan goes into intellectual territory that Fooled By Randomness almost but did not ultimately tread. The best way to distinguish the two books (and contrary to some book reviews out there, there definitely is a distinction) is via the following: Fooled By Randomness raised important and discomforting (which is precisely why it is important) questions about our understanding of, and decision making under, uncertainty.The Black Swan either answers many of the questions raised by the previous book and/or it provides a solid road map to arriving at whatever solutions (and there may ultimately be no solutions) that may exist to the fundamental problem of living in a world where changes in time and chance profoundly affect us all.

In other words, The Black Swan, the book, is one of the best maps available to help us navigate through a world of uncertainty. The idea of distinguishing between useful versus misleading maps is one of the themes that stood out in my mind as I read the book.Nassim Taleb mentions the analogy to maps in relation to his disdain for what he calls "Platonicity." Taleb defines Platonicity (named after the philosopher Plato) as "our tendency to mistake the map for the territory, to focus on pure and well-defined 'forms,' whether objects, like triangles, or social notions .... we privilege them over other less elegant objects, those with messier and less tractable structures ..." The cardinal sin of Platonicity is that it "makes us think that we understand more than we actually do."

Posner, along with a rogue's gallery of pseudo-experts (and, to be fair, real experts), advocate the use of Platonic Gaussian models of probability and risk despite the fact that one doesn't need to be Ramanujan or Karl Friedrich Gauss to figure out that events like 9/11 and many financial market crashes are double-digit sigma events, i.e., essentially impossible in the bell-curve, GIF world. Frankly, even from a textbook Gaussian perspective, many of these would-be Platonic 'mapmakers' are creating more confusion than clarity by their attempts to over-simplify the risky world we live in. Platonizers, like Posner, are essentially dismissing the possibilities of Black Swans, the concept; because they have seen thousands of white swans, they severely discount or completely dismiss the possibility that 'all swans aren't white.'

What Nassim Nicholas Taleb does so well in this book is to offer up an intellectual map of our risk-filled world (an a-Platonic map) that is more accurate and realistic than the pedantic view of chance that routinely misses the black swans. In The Black Swan, Taleb embraces the emerging scientific field of complexity theory  especially the fractal mathematics of Benoit Mandelbrot. Power law-Zipf-Mandelbrot-Pareto-Levy-whatever one wants to call it probability distributions, self-similarity / self-affinity, scale-free structures, undefined (or infinite) statistical moments, and 'wild,' fractal randomness, are what Taleb calls "Grey Swans of Extremistan," and they serve as viable alternatives to the Platonic models when it comes to understanding the high impact, almost unpredictable nature of extreme and catastrophic Black Swan events.

I was GIF'ed (and Why Crowds Can Never Be Wise)

When I took my first class in statistics (this was before Nassim Taleb started writing books), I faced an intellectual crises of confidence. I felt I was reasonably good at mathematics (at least the marks I received in math courses and exams said so), but some of what I was being told in my statistics class sounded daft to me.

My biggest dilemma was over the concept of 'outliers.' In a nutshell, outliers are observations or data points that are considered to be so far outside the range of the expected (or hoped for?).Bell-curve Gaussian density distribution that they could be ... ney, they should be! ... dismissed. I had a very serious problem with this cavalier dismissal of outliers. Why? It wasn't because I was too dull (or perhaps I was) to understand what the lecturer was saying or what was written in my introductory statistics textbook. I could deal with dogma as well as anybody. No, the problem went much deeper than that.

The 'outliers' -- what NNT calls Black Swans, the concept -- that my statistics class so easily waved away are what shaped my life and what shaped the lives of the people I was familiar with. The outliers the Black Swans  are what we for better or worse (usually the latter) lived by.
The Black Swan, the book, is the most important book in social science since Adam Smith's The Wealth of Nations.

So I'm sitting in my statistics class trying to get a fancy education, and I'm in the grips of an intellectual (and, almost, moral) dilemma. On the one hand, every fiber of my blue-collar common sense being wanted to point out that it is ridiculous to dismiss some infrequent or improbable event when it is precisely such events that may have the biggest impact in the real world (keep in mind, this was well before NNT started writing books and I had heard of Sextus Empiricus, et al.). From where I came in life, you'd have to be a dummy to think that some out-of-the-blue thing wouldn't change (usually, mess up ... I'm trying to avoid profanity) your life. On the other hand, I knew I would be considered an idiot or a worm by those 'better' than me if I seriously challenged the pedantic notion of outliers.

 I was a good boy and accepted the 'wisdom' of the bell-curve, along with the idea of outliers. But this always bothered me.

Fooled by Randomness (and later Black Swan) book was usually shelved in the business section in most bookstores, which automatically made me suspicious and reluctant to buy the book since I find most business books by business 'gurus' to be too vapid to be worth my time (I'd rather read a book by Kafka or a book on neuroscience, particle physics, or poker). I was pleasantly surprised to read Dr. Taleb's book. Here was someone who was my social 'better' giving me permission to think the way I always wanted to think. To me it was a proclamation of intellectual freedom.That is also why I am writing this ringing endorsement of Dr. Taleb's latest book, The Black Swan. As I wrote in the previous section, The Black Swan picks up where Fooled By Randomness left off. Any would-be intellectual explorer searching for truth in a world of uncertainty must buy and read these two books.

There is one book out there that I will never give a positive review to. I agree with the idea that a book should not be judged by its cover, but some things on the cover, in this case the title, are so odious to me that I can't possibly like it. There is a book out there called The Wisdom of Crowds; the title is daft. Crowds can't be wise. They can never be wise.

Yes, crowds can often have more information and, eeven, knowledge, but they may also be more ignorant than even the most marginalized individual. Crowds, or 'swarms,' can be more correct than individual judgments, but they can also be terrifically and terrifyingly wrong. But even if crowds were almost always better informed and almost always right, they can still never be wise.
Wisdom is an outlier; wisdom is a Black Swan. By its very nature, wisdom goes against the grain. Wisdom cannot be manufactured by groupthink, or by a swam of bildungsphilisters, or a bildungsphilister(s) that happens to get a publishing deal.

The Black Swan is full of that extremely rare and improbable quality, wisdom. As the book jacket states, The Black Swan, the book, is itself a Black Swan ... the good kind, the kind that is wisdom itself.

Ask your local mathematician to define probability, he would most probably show you how to compute it. As we saw in Chapter 3 on probabilistic introspection, probability is not about the odds, but about the belief in the existence of an alternative outcome, cause, or motive. Recall that mathematics is a tool to meditate, not compute. Again, let us go back to the elders for more guidance – for probabilities were always considered by them as nothing beyond a subjective, and fluid,measure of beliefs. 

Nassim Nichola Taleb

Black Swan Virgins (or Did They Really Get It?)

Needless to say, I have no serious criticism of The Black Swan, the book and the concept, or its author. But, since this is a (sort of) book review, I suppose I am expected to say something critical. In that case, the only criticism I can have is directed toward the potential readership of the book.
Most of the book reviews of The Black Swan (with one unfortunate exception) have been positive. As of the time of writing, the book is number five on the New York Times Bestsellers' List. Someone not having read, or not understanding, the book might conclude that all of this good news is confirmatory evidence that the public gets it ... they really understand the Black Swan, the concept and the main point of the book. Unfortunately, as much as I love the book, I am skeptical about whether the reading public really gets it or will get it.

The problem is not with the book, its author, or its editors. The book is well-written and well-thought out. There aren't any major errors or typos in it ... certainly, nothing that would cloud someone's understanding of the main points of the book. No, the problem lies with the readers themselves.

As I wrote in the last section, reading Dr. Taleb's previous book opened up intellectual vistas for me. But this made me wonder, "How can this guy with a fancy pedigree understand things that cab drivers, auto mechanics, factory workers, janitors, truck drivers, et al., understand but those socially 'better' than them not understand?" I eventually got the answers when I read Malcolm Gladwell's excellent profile of NNT in The New Yorker (you can get a similar biography by reading The Black Swan book). Taleb got it 'because' he had experienced Black Swans -- homeland and culture torn apart due to an out-of-the-blue event, and health problems that the GIF-prone mind couldn't have foreseen.

Nassim Taleb , inventer of Black Swan Theory
Lets make it clear that I do not want to make the same logical mistake the southern Italian professor makes in chapter six of the book. This mistake is something that the book constantly challenges. The mistake which Taleb calls "the round trip fallacy"  is really the idea of the sufficient condition being confused with the necessary condition in formal logic (e.g., "all poodles are dogs" does not make all dogs poodles). The mistake that the Italian professor makes in chapter six is a variant of this fallacy -- with the twist that the notion of assigning causality is involved along with the problem of sufficient vs. necessary.

(By the way, I strongly object to the Italian professor's characterization of Protestants as being incapable of appreciating Black Swans. As Rev. Thomas Bayes and Sir Dr. Karl Popper could have attested to, being Protestant is no impediment to believing in Black Swans.)

Clearly not all Lebanese Orthodox Christians who experienced the civil war and wound up becoming financial traders are Black Swan believing skeptical empiricists. What I am saying is that -- while it is not sufficient to have experienced (suffered) Black Swans to become a Black Swan believing skeptical empricist -- it is absolutely necessary.

It is interesting to note that the two people that Nassim Nicholas Taleb expresses the highest respect towards -- Benoit Mandelbrot and George Soros - are men who experienced Black Swans in their lives (escaping the Nazis during World War II). It is also interesting to note that my hero and the father of modern probability theory, the mathematician, Andrey Kolmogorov, experienced Black Swans in his life (lost both of his parents at an early age and was raised by his maternal aunts).
Benoit Mandelbrot

One of my other heroes, Ryszard Kapuscinski, would have loved Nassim Taleb's book. Kapuscinski would have really gotten it. It's not because of any quantitative ability; Kapuscinski wasn't Stanislaw Ulam. I doubt Kapuscinski could have solved a stochastic differential equation to save his life, or had the foggiest notion of what a power law or a fractal was.

But, time and time again, Kapuscinski experienced Black Swans. In fact, he made his career out of Black Swans by telling the stories of Black Swans that took the form of armed revolutions, ethnic conflict, deposed Middle Eastern shahs and African emperors, fearful and fleeing colonists, disintegerating empires, and wars fought over football (soccer).

Obviously, Nassim Taleb, as a financial trader, has had to take a tremendous amount of risks in his professional life. Ditto for George Soros.Benoit Mandelbrot has taken on a tremendous amount of risk intellectually. Instead of taking the safe and intellectually deadening route of most academics, he has worked at the margins to make the idea of fractals a viable academic discipline. A similar sort of thing could be said about Andrey Kolmogorov.

As for Ryszard Kapuscinski? He once asked the rhetorical question of why he did what he did, "Why do I risk my life time and time again?" Why did he risk his life time and time again when faced with murderous rebels, soldiers, and policemen? The answer: He was on a "mission" ... the mission was to get the story behind the story ... to get to the "essence of the truth."

So those who believe in the Black Swan often take incredible risks ... they've stared the Black Swan in its face and they often want to do it again and again. As Nassim Taleb has so eloquently answered his critics, it's not that he wants people to take no risks, it's that he doesn't want us to take risks in ignorance or blind to the reality of 'wild,' discontinuous randomness.

Other criticisms directed towards NNT -- that he is denying all casuality (no, he is not; he believes that assigning causal links should be based on skeptical empiricism -- which can include applying Einsteinian 'thought experiments'), or that he is opposed to all reductionism (i.e., Platonicity) in science (again, no; he -- as Einstein would have put it -- wants 'science' to be as simple as possible but no simpler) -- can be addressed in a similar fashion. But I must end this essay.

In closing, why am I so skeptical that potential readers (recognizing the fact that buying a book is not the same thing as reading it) won't really get it? Because many readers of this book -- especially the MBA totting types (or want-to-be's), and, I suspect, even people with solid scientific backgrounds -- are Black Swan virgins. They've won't really get it 'because' they have never really experienced Black Swans. I'm not saying these people have never experienced problems or challenges, it's just that the problems they have faced belong in Mediocristan while Black Swans are creatures of Extremistan (read the book and you will know what I mean).

I think Nassim Taleb makes the point about the importance of distinguishing between those who are experienced with Black Swans versus the Black Swan virgins eloquently in the Prologue of The Black Swan:
I don't particularly care about the usual. If you want to get an idea of a friend's temperament, ethics, and personal elegance, you need to look at him under the tests of severe circumstances, not under the regular rosy glow of daily life. ... the normal is often irrelevant.
There used to be a time when -- even in the swankiest professions and socio-intellectual circles -- there were some old-hands and young 'Horatio Algers' that had experienced Black Swans ... i.e., those who had been tested under severe circumstances. It might be a financial trader who had been affected by the Great Depression or had to flee their homeland with only a suitcase or two. It might be a scientist (natural or social) who survived a war, revolution, genocide, or a famine. It might be a student whose parents didn't know the lingua franca (usually English) and really knew what hardscrabble meant without ever having heard that word because he or she lived it.

 Tyranny of the Power Law -- that the very thing that brought the 'elite' success in life, the power law -- a symptom of the Black Swan, makes people blind to Black Swans by allowing the Black Swan blind to 'protect' themselves by entrenching their privilege.Anyone who reads and understands The Black Swan, the book, will realize, however, that this can't last. Black Swan virgins -especially those who are responsible for billions of dollars (or pounds, or Euros, etc.), or those responsible for the lives of millions (or even billions) of innocent people -- will eventually experience the Black Swan. Sadly, for innocent pension holders or even more innocent peace-loving, law-abiding citizens the world over, these Black Swan virgins won't know what to do. They'll fumble at the moment of destiny because they were blind to the fact that life is punctuated by extreme risks and they were blinded to that reality by the Platonized idea that risk can be 'managed' or controlled ... "risk leaps not glides."

Ten Principles of Black Swan-Proof World.

1. What is fragile should break early while it is still small. Nothing should ever become too big
to fail. Evolution in economic life helps those with the maximum amount of hidden risks – and
hence the most fragile – become the biggest.
2. No socialisation of losses and privatisation of gains. Whatever may need to be bailed out
should be nationalised; whatever does not need a bail-out should be free, small and riskbearing.
We have managed to combine the worst of capitalism and socialism. In France in the
1980s, the socialists took over the banks. In the US in the 2000s, the banks took over the
government. This is surreal.
3. People who were driving a school bus blindfolded (and crashed it) should never be given a
new bus. The economics establishment (universities, regulators, central bankers, government
officials, various organisations staffed with economists) lost its legitimacy with the failure of the
system. It is irresponsible and foolish to put our trust in the ability of such experts to get us out
of this mess. Instead, find the smart people whose hands are clean.
4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial
risks. Odds are he would cut every corner on safety to show “profits” while claiming to be
“conservative”. Bonuses do not accommodate the hidden risks of blow-ups. It is the asymmetry
of the bonus system that got us here. No incentives without disincentives: capitalism is about
rewards and punishments, not just rewards.
5. Counter-balance complexity with simplicity. Complexity from globalisation and highly
networked economic life needs to be countered by simplicity in financial products. The complex
economy is already a form of leverage: the leverage of efficiency. Such systems survive thanks
to slack and redundancy; adding debt produces wild and dangerous gyrations and leaves no
room for error. Capitalism cannot avoid fads and bubbles: equity bubbles (as in 2000) have
proved to be mild; debt bubbles are vicious.
6. Do not give children sticks of dynamite, even if they come with a warning . Complex
derivatives need to be banned because nobody understands them and few are rational enough
to know it. Citizens must be protected from themselves, from bankers selling them “hedging”
products, and from gullible regulators who listen to economic theorists.
7. Only Ponzi schemes should depend on confidence. Governments should never need to
“restore confidence”. Cascading rumours are a product of complex systems. Governments
cannot stop the rumours. Simply, we need to be in a position to shrug off rumours, be robust
in the face of them.
8. Do not give an addict more drugs if he has withdrawal pains. Using leverage to cure the
problems of too much leverage is not homeopathy, it is denial. The debt crisis is not a
temporary problem, it is a structural one. We need rehab.
9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement.
Economic life should be definancialised. We should learn not to use markets as storehouses of
value: they do not harbour the certainties that normal citizens require. Citizens should
experience anxiety about their own businesses (which they control), not their investments
(which they do not control).
10. Make an omelette with the broken eggs. Finally, this crisis cannot be fixed with makeshift
repairs, no more than a boat with a rotten hull can be fixed with ad-hoc patches. We need to
rebuild the hull with new (stronger) materials; we will have to remake the system before it does
so itself. Let us move voluntarily into Capitalism 2.0 by helping what needs to be broken break
on its own, converting debt into equity, marginalising the economics and business school
establishments, shutting down the “Nobel” in economics, banning leveraged buyouts, putting
bankers where they belong, clawing back the bonuses of those who got us here, and teaching
people to navigate a world with fewer certainties.

Result of Black Swan-Proof World:We will see an economic life closer to our biological environment: smaller companies,richer ecology, no leverage. A world in which entrepreneurs, not bankers, take the risks and companies are born and die every day without making the news.In other words, a place more resistant to black swans.

Even a book of rare genius like Nassim Nicholas Taleb's book - unless read carefully and with humility - can do much to prepare these Black Swan virgins. When they face their Black Swan -- what the truly great historians and thinkers used to call 'destiny' -- it will be too late. Well, that's life!

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