Summary:
Interview with Nassim Nicholas Taleb, author of "The Black Swan: The Impact of the Highly Improbable." Problem with probability theory: Fat Tony vs. Dr. John. On buying "out-of-the-money" options: when markets rise, they rise by small amounts, when they fall, they fall dramatically. Mediocristan vs. Extremistan. On banks and failing of Long Term Capital Management. Importance of religion and being ecologically conservative. Investment strategy: 90% in safest government securities, 10% high risk. (Published: 01/06/08)
Notes:
- most economists, and almost all bankers, are subhuman and very, very dangerous
- live in a fantasy world in which the future can be controlled by sophisticated mathematical models and elaborate risk-management systems
- in December lectured bankers at Société Générale
- told them they were sitting on a mountain of risks – a menagerie of black swans
- didn’t believe him
- six weeks later the rogue trader and black swan Jérôme Kerviel landed them with $7.2 billion of losses.
- "Clothes matter; they send signals"
- risk management
- facing up to those aspects of randomness about which something can be done
- “Scientists don’t know what they are talking about when they talk about religion. Religion has nothing to do with belief, and I don’t believe it has any negative impact on people’s lives outside of intolerance. Why do I go to church? It’s like asking, why did you marry that woman? You make up reasons, but it’s probably just smell. I love the smell of candles. It’s an aesthetic thing.”
- "Take away religion, and people start believing in nationalism, which has killed far more people."
- Religion as way of handling uncertainty
- lowers blood pressure
- thinks religious people take fewer financial risks
- obsessed with probability
- Brooklyn-born Fat Tony and academically inclined Dr John: two of Taleb’s creations
- You toss a coin 40 times and it comes up heads every time. What is the chance of it coming up heads the 41st time?
- Dr John gives the answer drummed into the heads of every statistic student: 50/50.
- Fat Tony says the chances are no more than 1%.
- “You are either full of crap,” he says, “or a pure sucker to buy that 50% business. The coin gotta be loaded.”
- chances of a coin coming up heads 41 times are so small as to be effectively impossible in this universe.
- It is far, far more likely that somebody is cheating.
- Fat Tony wins. Dr John is the sucker
- 1985: France, Germany, Japan, Britain and America signed an agreement to push down the value of the dollar
- held options that had cost him almost nothing and that bet on the dollar’s decline
- 1987 – Black Monday
- options were suddently worth a fortune
- became obsessed with buying “out of the money” options
- was sitting on a pile of out-of-the-money eurodollar options
- realised that when markets rise they tend to rise by small amounts, but when they fall – usually hit by a black swan – they fall a long way.
- on fall of Long-Term Capital Management
- hedge fund set up in 1994 by, among others, Myron Scholes and Robert C Merton
- joint winners of the 1997 Nobel prize in economics
- had grandest of all possible credentials and used the most sophisticated academic theories of portfolio management
- went bust in 1998 and, because it had positions worth $1.25 trillion outstanding, it almost took the financial system down with it
- modern portfolio theory had not accounted for the black swan, the Russian financial crisis of that year
- Mediocristan vs. Extremistan
- Mediocristan: where early humans lived
- Most events happened within a narrow range of probabilities – within the bell-curve distribution still taught to statistics students.
- we don’t live there any more.
- Extremistan: world we live in
- created world we don't understand
- black swans proliferate, winners tend to take all and the rest get nothing
- our systems are complex but over-efficient
- no redundancy, so a black swan strikes everybody at once
- banking system is the worst of all
- banks make money from two sources
- they take interest on current accounts and charges for services
- but they also take risks, big risks, with the whole panoply of loans, mortgages, derivatives and any other weird scam they can dream up.
- “Banks have never made a penny out of this, not a penny. They do well for a while and then lose it all in a big crash.”
- increased economic concentration has raised our vulnerability to natural disasters
- Kobe earthquake of 1995 cost a lot more than the Tokyo earthquake of 1923
- countless other ways in which we have built a world ruled by black swans – some good but mostly bad
- believes in tinkering
- Trial and error will save us from ourselves because they capture benign black swans
- three big inventions of our time: lasers, computers and the internet
- all produced by tinkering and none of them ended up doing what their inventors intended them to do
all were black swans
- big hope for the world is that, as we tinker, we have a capacity for choosing the best outcomes
- good investment strategy is to put 90% of your money in the safest possible government securities and the remaining 10% in a large number of high-risk ventures
- insulates you from bad black swans and exposes you to the possibility of good ones
- Your smallest investment could go “convex” – explode – and make you rich
- High-tech companies are the best
- The downside risk is low if you get in at the start and the upside very high
- Banks are the worst – all the risk is downside
- Don’t be tempted to play the stock market
- “If people knew the risks they’d never invest.”
- We should be mistrustful of knowledge. It is bad for us.
- Give a bookie 10 pieces of information about a race and he’ll pick his horses.
- Give him 50 and his picks will be no better, but he will, fatally, be more confident.
- We should be ecologically conservative:
- global warming may or may not be happening but why pollute the planet?
- "Taleb's top life tips"
- Scepticism is effortful and costly. It is better to be sceptical about matters of large consequences, and be imperfect, foolish and human in the small and the aesthetic.
- Go to parties. You can’t even start to know what you may find on the envelope of serendipity. If you suffer from agoraphobia, send colleagues.
- It’s not a good idea to take a forecast from someone wearing a tie. If possible, tease people who take themselves and their knowledge too seriously.
- Wear your best for your execution and stand dignified. Your last recourse against randomness is how you act — if you can’t control outcomes, you can control the elegance of your behaviour. You will always have the last word.
- Don’t disturb complicated systems that have been around for a very long time. We don’t understand their logic. Don’t pollute the planet. Leave it the way we found it, regardless of scientific ‘evidence’.
- Learn to fail with pride — and do so fast and cleanly. Maximise trial and error — by mastering the error part.
- Avoid losers. If you hear someone use the words ‘impossible’, ‘never’, ‘too difficult’ too often, drop him or her from your social network. Never take ‘no’ for an answer (conversely, take most ‘yeses’ as ‘most probably’).
- Don’t read newspapers for the news (just for the gossip and, of course, profiles of authors). The best filter to know if the news matters is if you hear it in cafes, restaurants... or (again) parties.
- Hard work will get you a professorship or a BMW. You need both work and luck for a Booker, a Nobel or a private jet.
- Answer e-mails from junior people before more senior ones. Junior people have further to go and tend to remember who slighted them.
