15 ms·

'Black swans' and 'perfect storms' become lame excuses for bad risk management

34 points by spathak 14y ago

batgaijin 14y ago
http://fooledbyrandomness.com/ForeignAffairs.pdf http://fooledbyrandomness.com/ForeignAffairs.pdf [pdf warning] Is a really good geopolitical paper I recently read about black swan stuff. The general gist, to my understanding, is that artificially supporting a regime makes it weaker.
konstruktor 14y ago
She obviously fails to grasp what Taleb calls a Black Swan, or ignores his definition for some cheap publicity: "The attacks of 9/11 were not black swans, she said. The FBI knew that questionable people were taking ﬂying lessons on large aircraft." They are the perfect example of a Black Swan. Quote Taleb (Black Swan, p.xxii): "... in spite of its outlier status, human nature makes us concoct explanations for its occurence after the fact, making it explainable and predictable", which is exectly what she is doing. And, one page later on 9/11: "had the risk been easily conceivable on September 10, it would not have happened". He is not advocating abandoning risk management, he is in favour of risk management that doesn't need us to predict the future, as it is harder to reliably estimate the likeliness of very unlikely events. Concerning the second example of earthquake risk and nuclear power plants: That, again, is a post-hoc rationalization. Everybody knew that earthquakes were a risk factor for NPP and was planning accordingly. They were just not planning for a Tsunami this size, as it was very, very unlikely. So including higher error margins for earthquakes next time is nice but not enough. Taleb on this: http://www.valuewalk.com/2011/03/nassim-taleb-black-swans/ http://www.valuewalk.com/2011/03/nassim-taleb-black-swans/ Consider the aviation industry: After an accident, they find the root cause and eliminate it. It is now something expected, and can be directly dealt with. But also try to improve the system (e.g. via training) to be more robust towards all the root causes the didn't anticipate.
- jacques_chester 14y ago
  > They are the perfect example of a Black Swan. I disagree. The black swan is something that is completely unforeseeable and for which there are no previous partial or complete examples, either of the final outcome or the contributing causes. Which is her point: 9/11 was foreseeable from the information (the failure was in connecting it) and the fact that a previous, similar plot had been tried in France. The clues were there and there was a previous partial example.
  - clicks 14y ago
    > The black swan is something that is completely unforeseeable and for which there are no previous partial or complete examples, either of the final outcome or the contributing causes. There is no such thing as something completely, entirely 100% unforeseen or unforeseeable. Someone, somewhere in the world will be seeing it coming... just as some intelligence analysts saw 9-11 coming, some economists saw the financial crisis, etc. etc. What we're considering is what the prevailing and strongly established consensus well outside the fringe areas says.
    - jacques_chester 14y ago
      This is where we start to wander into problems with classical set logic. No, I'm not joking. Fuzzy sets are pretty much required for any meaningful discussion of "failed", "foreseeable" etc, if they are to be at all useful concepts: http://chester.id.au/2012/04/09/review-drift-into-failure/ http://chester.id.au/2012/04/09/review-drift-into-failure/ Reduce foreseeability and failure to a binary toggle and you destroy enormous amounts of information with high utility so that some syllogisms still work. Wasteful. Taleb is a very intelligent man, but AFAICT he does often reinvent existing concepts with much cooler names. "Antifragile" sounds awesome. "Robust" sounds boring. Take "black swan", for example. Given the technology of the day, black swans simply didn't exist. Iain Banks called these "Outside Context Problems", one might also call them "paradigm-busters". Anyhow. I should have padded out my original definition with the usual legalese about "reasonably foreseeable".
      - dodo53 14y ago
- pirate80 14y ago
  The point of engineering approach to risk management the author makes while suggesting Black Swan phenomenon is something Taleb is actually suggesting by making systems anti-fragile in his new book.
jbert 14y ago
This is one thing to me which seems to me to be a genuine failing of an efficient market. Over the medium term, ignoring the low-frequency, high-risk event gives you a margin over your competition. Hence you succeed at their expense and they fail/get bought out by you etc. As a simple example (the general argument applies to all sectors and all forms of risk), consider a bank ("safe bank") keeping $X in reserve to handle unforeseen events. Another bank ("risky bank") which keeps only $X/2 in reserve. Risky bank will have a advantage over safe bank at all times except when an event requiring between $X/2 and $X occurs. Should such a rare event occur, risky bank would fail and safe bank survive. Once the frequencies of such events drop to low enough levels (once ever 5? 10? 20? 40? years), there is no market pressure on the riskier bank to plan for the problem (and in fact the opposite, the market will destroy safe bank). The actual time period is I think determined by how long it takes risky bank to out-compete safe bank and so drive it from the market as a significant force.
- jacques_chester 14y ago
  > This is one thing to me which seems to me to be a genuine failing of an efficient market. You seem to assume that all risk is meant to be carried by the banks. As you note, such a thing is possible (up to the risk-bearing capacity of any given bank), but such banks would be very expensive. Consequently, most customers bank with riskier institutions and this places more of the risk back onto them. So, in actual fact, this is the market doing what it does pretty well: solving a hyper-distributed problem with heterogenous agents with numerous complex, incompatible preferences. Sometimes we don't like the outcome. That doesn't mean that the market has "failed"; it just means that we don't like the outcome.
  - ordinary 14y ago
    The market is a solution to a problem (or perhaps a set of problems). In the example of in the grandparent's post, that solution does not adequately deal with the problem at hand. This makes it a bad solution. Even if we can't think of a better solution right now, we shouldn't stick our collective heads in the sand when we notice errors in our current approach. Highlighting errors is important, because even if we can't fix them right now, we may be able to in the future. If we don't know about the flaws in our current approach, it it impossible to even attempt to think of ways to improve them.
mbesto 14y ago
I've said it before and I'll say it again. If you want to understand more about this (especially economically), Daniel Kahneman's Thinking, Fast and Slow spells it out really well: http://www.amazon.com/Thinking-Fast-Slow-Daniel-Kahneman/dp/0374275637/ref=sr_1_1?ie=UTF8&qid=1355912148&sr=8-1&keywords=thinking+fast+and+slow http://www.amazon.com/Thinking-Fast-Slow-Daniel-Kahneman/dp/...
- anythinggoes 14y ago
  One major reason why I disagree with the article. Social phenomena are impossible to fully compute as human beings do not just apply to comprehensible laws of physics, but there is a whole different dynamic of behavioral and social factors involved that makes statistic modelling a great deal more complex. Unlike the author I also do not think that this problem can just be resolved with technical means, there will always be uncertainty about human behavior and thus Black Swans.
  - mbesto 14y ago
    Ya, this part irked me the most: "Traditional financial analysis, she said, is based on evaluating existing statistical data about past events. In her view, analysts can better anticipate market failures – like the financial crisis that began in 2008 – by recognizing precursors and warning signs, and factoring them into a systemic probabilistic analysis." So, let's say you do provide a systemic probabilistic analysis about the impending education crisis the US is about hit? Don't you think a government would be gnawing their hands off to get that type of statistical analysis? Personally, I don't think it systematically exists.
leashless 14y ago
We call this phenomenon "black elephants." You have an elephant in the room. After it explodes, everyone will say it was a black swan.
- batgaijin 14y ago
  Like the Chinese housing bubble?
EzGraphs 14y ago
Taleb's emphasis in his latest book is on avoiding the naive attempt to predict the unpredictable. Instead, focus on identifying and making things "Antifragile" so that they are resistant to (or even benefit from) events that would otherwise be destructive. With that in mind, risk management becomes much less about guessing about the future. Instead, the focus is to identify the fragile (that which is highly susceptible to disruption) and take steps to make it antifragile. http://www.amazon.com/Antifragile-Things-That-Gain-Disorder/dp/1400067820 http://www.amazon.com/Antifragile-Things-That-Gain-Disorder/... It is an enjoyable read so far...

34 points by spathak 14y ago

http://fooledbyrandomness.com/ForeignAffairs.pdf http://fooledbyrandomness.com/ForeignAffairs.pdf [pdf warning] Is a really good geopolitical paper I recently read about black swan stuff. The general gist, to my understanding, is that artificially supporting a regime makes it weaker.

konstruktor 14y ago

She obviously fails to grasp what Taleb calls a Black Swan, or ignores his definition for some cheap publicity: "The attacks of 9/11 were not black swans, she said. The FBI knew that questionable people were taking ﬂying lessons on large aircraft." They are the perfect example of a Black Swan. Quote Taleb (Black Swan, p.xxii): "... in spite of its outlier status, human nature makes us concoct explanations for its occurence after the fact, making it explainable and predictable", which is exectly what she is doing. And, one page later on 9/11: "had the risk been easily conceivable on September 10, it would not have happened". He is not advocating abandoning risk management, he is in favour of risk management that doesn't need us to predict the future, as it is harder to reliably estimate the likeliness of very unlikely events. Concerning the second example of earthquake risk and nuclear power plants: That, again, is a post-hoc rationalization. Everybody knew that earthquakes were a risk factor for NPP and was planning accordingly. They were just not planning for a Tsunami this size, as it was very, very unlikely. So including higher error margins for earthquakes next time is nice but not enough. Taleb on this: http://www.valuewalk.com/2011/03/nassim-taleb-black-swans/ http://www.valuewalk.com/2011/03/nassim-taleb-black-swans/ Consider the aviation industry: After an accident, they find the root cause and eliminate it. It is now something expected, and can be directly dealt with. But also try to improve the system (e.g. via training) to be more robust towards all the root causes the didn't anticipate.

jacques_chester 14y ago
> They are the perfect example of a Black Swan. I disagree. The black swan is something that is completely unforeseeable and for which there are no previous partial or complete examples, either of the final outcome or the contributing causes. Which is her point: 9/11 was foreseeable from the information (the failure was in connecting it) and the fact that a previous, similar plot had been tried in France. The clues were there and there was a previous partial example.
- clicks 14y ago
  > The black swan is something that is completely unforeseeable and for which there are no previous partial or complete examples, either of the final outcome or the contributing causes. There is no such thing as something completely, entirely 100% unforeseen or unforeseeable. Someone, somewhere in the world will be seeing it coming... just as some intelligence analysts saw 9-11 coming, some economists saw the financial crisis, etc. etc. What we're considering is what the prevailing and strongly established consensus well outside the fringe areas says.
  - jacques_chester 14y ago
    This is where we start to wander into problems with classical set logic. No, I'm not joking. Fuzzy sets are pretty much required for any meaningful discussion of "failed", "foreseeable" etc, if they are to be at all useful concepts: http://chester.id.au/2012/04/09/review-drift-into-failure/ http://chester.id.au/2012/04/09/review-drift-into-failure/ Reduce foreseeability and failure to a binary toggle and you destroy enormous amounts of information with high utility so that some syllogisms still work. Wasteful. Taleb is a very intelligent man, but AFAICT he does often reinvent existing concepts with much cooler names. "Antifragile" sounds awesome. "Robust" sounds boring. Take "black swan", for example. Given the technology of the day, black swans simply didn't exist. Iain Banks called these "Outside Context Problems", one might also call them "paradigm-busters". Anyhow. I should have padded out my original definition with the usual legalese about "reasonably foreseeable".
    - dodo53 14y ago
pirate80 14y ago
The point of engineering approach to risk management the author makes while suggesting Black Swan phenomenon is something Taleb is actually suggesting by making systems anti-fragile in his new book.

jbert 14y ago

This is one thing to me which seems to me to be a genuine failing of an efficient market. Over the medium term, ignoring the low-frequency, high-risk event gives you a margin over your competition. Hence you succeed at their expense and they fail/get bought out by you etc. As a simple example (the general argument applies to all sectors and all forms of risk), consider a bank ("safe bank") keeping $X in reserve to handle unforeseen events. Another bank ("risky bank") which keeps only $X/2 in reserve. Risky bank will have a advantage over safe bank at all times except when an event requiring between $X/2 and $X occurs. Should such a rare event occur, risky bank would fail and safe bank survive. Once the frequencies of such events drop to low enough levels (once ever 5? 10? 20? 40? years), there is no market pressure on the riskier bank to plan for the problem (and in fact the opposite, the market will destroy safe bank). The actual time period is I think determined by how long it takes risky bank to out-compete safe bank and so drive it from the market as a significant force.

jacques_chester 14y ago
> This is one thing to me which seems to me to be a genuine failing of an efficient market. You seem to assume that all risk is meant to be carried by the banks. As you note, such a thing is possible (up to the risk-bearing capacity of any given bank), but such banks would be very expensive. Consequently, most customers bank with riskier institutions and this places more of the risk back onto them. So, in actual fact, this is the market doing what it does pretty well: solving a hyper-distributed problem with heterogenous agents with numerous complex, incompatible preferences. Sometimes we don't like the outcome. That doesn't mean that the market has "failed"; it just means that we don't like the outcome.
- ordinary 14y ago
  The market is a solution to a problem (or perhaps a set of problems). In the example of in the grandparent's post, that solution does not adequately deal with the problem at hand. This makes it a bad solution. Even if we can't think of a better solution right now, we shouldn't stick our collective heads in the sand when we notice errors in our current approach. Highlighting errors is important, because even if we can't fix them right now, we may be able to in the future. If we don't know about the flaws in our current approach, it it impossible to even attempt to think of ways to improve them.

mbesto 14y ago

I've said it before and I'll say it again. If you want to understand more about this (especially economically), Daniel Kahneman's Thinking, Fast and Slow spells it out really well: http://www.amazon.com/Thinking-Fast-Slow-Daniel-Kahneman/dp/0374275637/ref=sr_1_1?ie=UTF8&qid=1355912148&sr=8-1&keywords=thinking+fast+and+slow http://www.amazon.com/Thinking-Fast-Slow-Daniel-Kahneman/dp/...

anythinggoes 14y ago
One major reason why I disagree with the article. Social phenomena are impossible to fully compute as human beings do not just apply to comprehensible laws of physics, but there is a whole different dynamic of behavioral and social factors involved that makes statistic modelling a great deal more complex. Unlike the author I also do not think that this problem can just be resolved with technical means, there will always be uncertainty about human behavior and thus Black Swans.
- mbesto 14y ago
  Ya, this part irked me the most: "Traditional financial analysis, she said, is based on evaluating existing statistical data about past events. In her view, analysts can better anticipate market failures – like the financial crisis that began in 2008 – by recognizing precursors and warning signs, and factoring them into a systemic probabilistic analysis." So, let's say you do provide a systemic probabilistic analysis about the impending education crisis the US is about hit? Don't you think a government would be gnawing their hands off to get that type of statistical analysis? Personally, I don't think it systematically exists.

leashless 14y ago

We call this phenomenon "black elephants." You have an elephant in the room. After it explodes, everyone will say it was a black swan.

batgaijin 14y ago
Like the Chinese housing bubble?

EzGraphs 14y ago

Taleb's emphasis in his latest book is on avoiding the naive attempt to predict the unpredictable. Instead, focus on identifying and making things "Antifragile" so that they are resistant to (or even benefit from) events that would otherwise be destructive. With that in mind, risk management becomes much less about guessing about the future. Instead, the focus is to identify the fragile (that which is highly susceptible to disruption) and take steps to make it antifragile. http://www.amazon.com/Antifragile-Things-That-Gain-Disorder/dp/1400067820 http://www.amazon.com/Antifragile-Things-That-Gain-Disorder/... It is an enjoyable read so far...