The black swan and risk

Nassim Taleb’s The Black Swan is an excellent read about unpredictability, risk, forecasting, and falsification. A black swan is an event with three distinct characteristics: 1) it is unexpected, 2) its impact is profound, and 3) we explain its occurrence too readily (and incorrectly) by invoking hindsight bias. Examples of black swans include 9/11 attacks, Trump’s presidential victory, or the international success of Jordan Peterson’s book 12 Rules for Life

Taleb’s book is full of insight, and he does an excellent job of demonstrating how we tend to underappreciate many essential concepts. Consider the problem of risk and casinos. Casinos have to manage risk to remain profitable. Odds in any game are stacked against individual players, especially in the long run. Even the risk of a “whale” (a high roller) getting “hot” can be factored in. Overall, then, casinos are very good at managing game related risks using mathematical modeling. 

The problem with black swans is that they escape mathematical models – they are profoundly unpredictable and consequential. Taleb gives an example of a casino that almost went bankrupt because of exposure to four black swan events:

  1. A highly popular stage performer was mauled by a tiger he raised. Casino managers thought of buying insurance against the tiger lashing out at audience members, but no one thought to insure the actual performer. The attack resulted in a loss of millions of dollars given the popularity of the show.
  2. When a daughter of a casino owner was kidnapped, he (illegally) reached into casino’s coffers to pay the ransom. 
  3. A construction worker injured on the job was offered a settlement. However, the included amount was so low that he felt insulted and planned (but failed) to blow up the casino.
  4. One of the employees failed to mail routine paperwork that almost resulted in a loss of a gambling license.

In short, even casinos are not good in managing risks. Unpredictability is not easily contained. Taleb presents and defends many other unique ideas in his book. Here are some examples:

  1. Reading newspapers daily makes you know less about the world (if you have to read newspapers, read weekly magazines).
  2. Books you have not read are more valuable than the books you have read.
  3. Luck is significantly underrated.

This book should be of interested to anyone interested in sharpening his/her analytical skills. However, above all else, social scientists reading the book will be challenged to think much more carefully about causality and unpredictability.

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