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The highly improbable

Filed in: risk, nassim nicholas taleb, catastrophy, improbable

Book review of Nassim Nicholas Taleb's "The Black Swan"

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Bookshelf: The highly improbable
Date: 11-Jul-07 Richard Willsher, World Business

The world is a risky place - but by using the right tools we can reduce the uncertainty.
The world is a risky place. Its very nature is that it is subject to unexpected and catastrophic events. Yet, by using the wrong tools to assess risk, we choose to convince ourselves that things are less risky than they are.

The great thing about Nassim Nicholas Taleb’s The Black Swan is that it teaches us to look at risk and uncertainty in a different way, using approaches that distrust standard means of calculating or estimating risk. The idea of the black swan is that once it had been discovered, it highlighted how fragile knowledge and information had been among those who thought swans were always and necessarily white simply because they had never seen a black one.

Taleb defines a black swan as “something that lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries extreme impact and third, in spite of its out-lier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.”

Much of the early part of the book is devoted to attacking states of mind and, more particularly, statistical techniques that ignore or insulate us from black swan-like phenomena. These belong to the province of ‘Mediocristan’, which is “dominated by the mediocre, with few extreme successes or failures” where “no single observation can meaningfully affect the aggregate”. This is an unrealistic place: in reality, life in general and business in particular are located in another country altogether, one called ‘Extremistan’. Here, “the total can be conceivably impacted by a single observation”.

It may be a weakness of the book that the author spends much of his time reasoning in the abstract and that too many pages are devoted to close, bookish argument. The busy business reader may lose patience and cast the book aside. Instead, I recommend you just skip the bits that bore you (and Taleb suggests as much himself from time to time) and cut to the chase. Just think: 9/11, Katrina, tsunami, sudden death among people you know, and the dominance of a Microsoft or a Google in their separate fields - all phenomena that virtually no one saw coming and if they had, did little or nothing about.

The point about Microsoft and Google is that black swans are not just negative phenomena, but also positive ones. If you arrange your business or your investment portfolio in such a way that it can benefit from black swans, should one float into your field of operations, then you can achieve extraordinary results that are way off the radar of ‘business as usual’ if your bet comes off.

The author unleashes his eccentric wit on lesser mortals from time to time, including bankers (“we humans have the largest cortex, followed by bank executives, dolphins and our cousins the apes”), analysts, economists, other philosophers, journalists, book reviewers and business executives. “Being an executive does not require very developed frontal lobes, but rather a combination of charisma, a capacity to sustain boredom and the ability to shallowly perform on harrying schedules.”

This is one of those books that one is likely to go back to because it frees one from the shackles of standard thinking and institutionalised ways of estimating risk and reward. Moreover, the book’s disdain enables one to engage in healthy scepticism about the merits of being a corporate suit. The Catch-22, of course, is that black swans are unpredictable and so by definition we will never be able to anticipate their appearance and their impact. But this is to miss Taleb’s point. This is not a book about reading the future.

“We are quick to forget,” he writes, “that just being alive is an extraordinary piece of good luck, a remote event, a chance occurrence of monstrous proportions.” For Taleb, life itself is the result of a series of acts of chance, the outcome of a coincidence of uncertainties. So if in measuring uncertainty, you ignore accident and unpredictable - and sometimes very large - deviations from the norm, then it is “like focusing on the grass and missing out on the trees”.

This is an exciting and frightening state of mind to live with. It is not comfortable, but in business terms it is to live in the real world rather than that circumscribed by planning and risk analysis based purely on looking into a rear-view mirror.

The Black Swan: the impact of the highly improbable, Nassim Nicholas Taleb, Allan Lane, £20, ISBN: 0-71399-995-0.