November 16, 2010
Black Swans and Accepting Uncertainty
Posted by Jeff Schwartz

In my last post, I argued that, since we don’t have a crisp picture of what constitutes a black swan, it’s not worth arguing about whether our recent financial collapse qualifies.  I think, however, that important insights underlie the notion of black swans, which are useful to keep in mind.

A weakness in the black-swan analogy is that it implies that we can clearly label events as either foreseeable or unforeseeable.  But this is difficult, if not impossible.  Events aren’t foreseeable or unforeseeable.  They are more foreseeable or less foreseeable.  Some things are easy to predict (the sun will rise tomorrow); some things are hard (when will the economy recover?).

The important insight that may get lost when we attempt to categorize events is that transformative occurrences may be on the unforeseeable side of the spectrum (indeed, they may be very difficult to foresee).  This strikes me as counterintuitive and interesting.  Our inclination is to think that the bigger something is, the easier it is to see coming.  In fact, however, the opposite is likely true. 

That large-scale events are difficult to foresee is also a bit unsettling.  We like to think that we can foresee, and therefore plan for, major events.  But our ability to do so is limited.  Similarly, we like to think that we can rely on mainstream economic forecasts and expert opinions.  But this frequently isn’t true.

My biggest takeaway from the black-swan metaphor is that we need to acknowledge that high impact, largely unexpected, events will continue to knock us around.  As Taleb has argued, this means that financial models need to take the possibility of low-probability events into account and that individuals and institutions need to take steps to insure against them.  

A failure to heed these insights can be seen as a contributing factor to the financial collapse.  Going forward, this recognition of society’s limited predictive powers suggests the need to build a financial infrastructure that is more resistant to such shocks.

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