Learning from the Black Swan

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Nassim Nicholas Taleb was right. The world financial system was recently devastated by unpredicted catastrophes of grand proportion – a financial black swan – and struggles today to recover and explain the carnage. Taleb predicted such an event in his 2007 bestseller The Black Swan, The Impact of the Highly Improbable. In 2005, Taleb took on the investment community with his highly entertaining Fooled by Randomness: The Hidden Role of Chance in the Markets and in Life., in which he assails the financial services community for its dumb luck, its hubris and its reckless conduct.* With no shortage of ego, Taleb iterates his financial doom and gloom theme with a vengeance in a Feb 2, 2009 Forbes interview, castigating the industry for its overconfidence and its lax risk-control models built on faulty assumptions. For Taleb, the extraordinary booms and busts experienced over the last 20 years are far outside the tidy predictions of our cherished bell curve models. Fat tails are, unfortunately, facts of financial life.

I wrote an article on Fooled By Randomness for Information Management last year in which I focused less on the financial implications of Taleb’s meanderings than his insights on human behavior. It seems people are often deluded in attributing causes of their own behavior. Success is generally interpreted in a strict causal trail of events – I did such-and-such which resulted in a favorable outcome — while failure is simply bad luck, or random. Survivorship bias occurs when the weak die young, thus skewing results toward the successes still alive. It’s all too easy to forget the deceased. Hindsight bias, a particularly pernicious human foible, allows failings to be adroitly “predicted” after the fact – I knew it all along. And the narrative fallacy allows us to fool ourselves with anecdotes and stories, which are much “easier” than rigorous evidence. Finally, humans expect progress to be linear, when it often plays out like an S Curve: “Tomato ketchup in a bottle – None will come and then the lot’ll”.

The antidote for these flawed explanations of cause and effect? None other than the hypothesize/test/learn cycle outlined in an earlier blog.

L. Gordon Crovitz, Information Age columnist for the WSJ, offers hope in a February 9, 2009 article with observations from the latest Technology, Entertainment and Design (TED) conference. He cites linked data, an exciting concept proposed by Tim Berners-Lee, inventor of the World Wide Web, which will facilitate correlating digital data in disparate formats. Linked data will enable analysts to better formulate and test business performance hypotheses using the Web, thus providing a more scientific basis for decision-making. Indeed, Berners-Lee thinks linked data may be the salvation of financial services, promoting an intelligent antidote to flying blind with new — and risky — financial instruments.

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