The Impact of the Highly Improbable

Author Nassim Nicolas Taleb

For centuries, the laws of probability and every day experience informed people that all swans are white. Anyone who said that black swans existed would be thought delusional. Then, the discovery of Australia--and home to a species of black swans--upset both certainty and probability. What had been impossible had become probable, especially if you were visiting kangaroo country.

Here's a probability test that you may remember from High School: What are the chances that a tossed coin will land heads up? Fifty percent, right?

What if the coin was tossed forty-nine times and each time it landed heads up? What are the chances that the coin will land heads up on the fiftieth toss? Experts--our High School math teacher and Nobel Prize winning scientists alike--will tell us that it is still fifty percent, no matter how many times it landed heads up on prior tosses.

These experts are all wrong, according to Taleb. In his view, financial planners, economists, and fund managers have become so enslaved to statistical models and technology driven forecasting systems that they have allowed machines to do their thinking for them. This, of course, has made the experts very angry: few books have been more thoroughly trashed than has The Black Swan.

In the case of the tossed coin example above, we know that the coin must either be loaded, or that the person tossing coin has the help of a divine benefactor: it's a miracle Dude! What we often overlook is the possibility that it is a "Black Swan," something that can't be explained simply through probability or statistical modeling. Non-expert street smart guys, and the average skeptic, often know to look outside the rules of probability for why things happen the way they do. The models and systems they use are ones that also factor in luck, acts of God, and randomness--all things experts refuse to consider unless they can be treated as "risk management" factors that are gradable on the curve.

According to Taleb, the world is far more random and riskier than can be accounted for by theories, economic models, predictions, or probability tables upon which our political and financial leaders plan their, and our, destinies. "These people [the experts] are empty suits," Taleb says. "They all look at the same numbers and arrive at the same destination. They can't account for the Black Swan, so they ignore it."

One illustrative point that Taleb uses is the volatile price of oil. Experts tell us that a variety of factors--increased demand by emerging economies, the low value of the dollar, and so on--provide rational explanations why we all got nailed--and will be nailed again--by high fuel prices. The same experts inform us that the high oil prices of a year ago were inevitable. Taleb asks these experts two questions:

First, if high oil prices were inevitable, why haven't all the experts who "knew" about the inevitability of high oil prices grown rich on their investments in oil futures? Second, why have oil company executives been given millions of dollars in performance bonuses if the improved performance of their companies was inevitable and not--as these executives testified before Congress--due to their managerial wizardry? A question we might all ask is why these oil company executives haven't given their performance bonuses back since they have testified that they are "merely observers of supply and demand?"

Taleb says that, among the reasons why, is that businesses and governments have been hijacked by a managerial class that gets paid regardless of how well they perform. When a "Black Swan" event appears--like the "100 Year" flood in Iowa in 1993 and the "500 Year" flooding last spring (15 years later)--the experts point to the data and exclaim "what a surprise!" They confidently predict 100 and 500 year cycles but can't reliably tell us if it will rain tomorrow.