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Black Swan Theory by sudhakar, Head Markering, codezene (P) ltd

Black Swan Theory

By : sudhakar, Head Markering, codezene (P) ltd
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black swan theory

Activity:  4 comments  136 views  last activity : 08 06 2011 01:10:52 +0000
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IS  JAPANESE  DISASTER  A “BLACK SWAN”  EFFECT?
Nassim Nicholas Taleb, author of a famous book: The Black Swan: The Impact of the Highly Improbable:2007, is also Distinguished Professor of Risk Engineering at New York University, was besieged with 600 interview requests, after Japanese Disaster, which he refused to give, but gave his account on the subject.
A “black swan” is a metaphor used by philosophers over the centuries to capture the surprise effects of scientifically improbable and therefore unexpected events on history, inspired by the 17th century discovery of black swans in Australia when biologists had previously declared all swans were white swans.
In Taleb’s definition, a black swan event has three conditions:
  1. It is an “outlier,” a highly unexpected event with little historic evidence warning us of its prospective occurrence.
  2. The event has extreme impact.
  3. Although the event is a black swan,  we concoct explanations for the event after the fact, making it palatable and predictable.
“We don’t understand the world as well as we think we do and tend to be fooled by false patterns. We mistake luck for skills (the fooled by randomness effect), overestimate knowledge about rare events (Black Swans), as well as human understanding, something that has been getting worse with the increase in complexity.”
The results of Black Swans are unforeseen global dislocations in markets and societies for which we are repeatedly unprepared (the 2007 financial crash, for example).  Taleb argues that most consequential events in history are black swans, and investors, managers, and policymakers repeatedly underestimate risk and instability.
In The Black Swan, Taleb seeks to help “robustify” us against the risk of future Black Swan events.  What happens to a turkey at Thanksgiving is a black swan event for the turkey, but not the butcher, Taleb explains.
In  Note 142 of his blog, Taleb offers additional insights.
  • The improbable happens. He cites Japan’s Nuclear Commission policy that a fatality risk from a nuclear accident is about one incident per million years–a policy written just eight years ago.  Therefore, an event the authorities projected as minutely improbable–a once in a million year event–occurred less than a decade later.
  • Small probabilities tend to be hard to compute; the smaller the probability, the harder;
  • Survivorship bias: if you compute the likelihood of an event that threatens your survival, you will inevitably underestimate its probability;
  • Having faith in predictions about young industries is dangerous. It is one thing to make models based on the natural world for which we have 3 billion years of experience–it is another, more dangerous thing to trust models about the nuclear power industry which has been in existence for 60 years;
  • Because of globalization, the costs of natural catastrophes are increasing in a nonlinear way. We’re so interconnected by information and large institutions that events build momentum quickly: a real tsunami generates a tsunami of reactions and decisions.
Further insights into Taleb’s advice are best captured in his ten principles for a black swan proof society, published in the second edition of The Black Swan–we cite a few here:
  • “What is fragile should break early while it’s still small: Nothing should ever become too big to fail.” A lesson to heed now about nuclear power?
  • “People who drove a school bus blindfolded (and crashed it) should never be given a new bus: The economics establishment lost its legitimacy with the failure of the system in 2008. Find the smart people whose hands are clean to get us out of this mess.”
  • “Don’t let someone making an “incentive” bonus manage a nuclear plant - or your financial risks: Odds are he would cut every corner on safety to show “profits” from these savings while claiming to be ‘conservative’.”
  • “Compensate complexity with simplicity: Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products.”–An excellent insight for managers.
  • “Do not give children sticks of dynamite, even if they come with a warning label.”  In other words, know what is too complicated to manage effectively in a Black Swan world, and outlaw it.
  • “Make an omelette with the broken eggs: The crisis of 2008 was not a problem to fix with makeshift repairs.”–In the aftermath of a major Black Swan event, don’t fix things piecemeal or with the same assumptions.  Don’t be afraid to start over. Expect the extraordinary, and plan as if its ordinary.
 
What do you think about the Black Swan theory?
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4 comments on "Black Swan Theory"
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  Commented by  Krishnamurthy Prabhakar, Professor, Velammal Engineering College    | 08 06 2011 01:10:52 +0000 
Thank you Sudhakar for summarizing a complex phenomena into a short and understandable way. The Blackswan events are not confined to the geological or volcanic or natural phenomena only. The events have least probability and we try to underestimate their capability to damage the society and the world. Why we tend to underestimate their potential? The one in million chances of getting contaminated in Japan has happened in just one decade. The infallibility of US economy made itself vulnerable with likely default. How do we explain all these events with least probability of happening? Blackswan offers some solutions but not all. However, it is scientific and iconoclastic.
  Commented by  Mohammad Bakhsh, Project Leader/Managing Consultant, Freelancer    | 07 11 2011 03:11:47 +0000 
Thanks,Sudhakar for explaining 'Black Swan Theory'. I do not believe in this theory.I base  natural calamities are the result of imbalance created by igneous rock.Igneous rock is formed through the cooling and solidification of magma or lava. Igneous rock may form with or without crystallization, either below the surface as intrusive (plutonic) rocks or on the surface as extrusive (volcanic) rocks. This magma can be derived from partial melts of pre-existing rocks in either a planet's mantle or crust. Typically, the melting is caused by one or more of three processes: an increase in temperature, a decrease in pressure, or a change in composition. Over 700 types of igneous rocks have been described, most of them having formed beneath the surface of Earth's crust. These have diverse properties, depending on their composition and how they were formed.You can assume lot of activities are taking place underneath us so Tsunami, Earthquakes,Cyclone are devastating effects.
So I believe that comprehensive checks have to carried out before proposing Nuclear Plants or even Thermal Plants.
  Commented by  Sanjay Bhardwaj, Partner/Principal/VP, BPL Ltd, Health Management Solution    | 07 10 2011 14:17:29 +0000 
Guess Taleb failed to include the Chernobyl disaster as a part of recent nuclear disaster, yes i do endorse his theory of Black Swan but the events of 2008 financial disaster had it seeds some where else, with the greedy bankers of USA that eventually culminated in global meltdown, somehow I subscribe to part theory and not fully to 2008 global financial meltdown.
  Commented by  sudhakar, Head Markering, codezene (P) ltd    | 07 10 2011 13:57:21 +0000 
IT IS NICE A ONE AND HENCE SHARED.
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True. This is primarily because of the modern world is more self conscious and hardly having time to think on what others are doing.
These things are just beyond reality. The person who understand himself better can alone understand this high spirituality theory. Dr. Ray thanks for sharing.
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