"What we call here a Black Swan is an event with the following three attributes. First, it is an outlier, as it lies outside the realm of regular expectation, because nothing in the past can convincingly point to it's possibility. Second, it carries an extreme impact. Third, in spite of its outlier status human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable." P:xxii
"Our inability to predict in environments subjected to the Black Swan, coupled with a general lack of the awareness of this state of affairs, means that certain professionals, while believing they are experts, are in fact not. Based on their empirical record, they do not know more about their subject matter than the general population, but they are much better at narrating - or, worse, at smoking you with complicated mathematical models. They are also more likely to wear a tie.
Black Swans being unpredictable, we need to adjust to their existence (rather than naively predict them). There are so many things we can do if we focus on antiknowledge, or what we do not know. Among many other benefits, you can set yourself up to collect serendipitous Black Swans (of the positive kind) by maximizing your exposure to them. Indeed, in some domains - such as scientific discovery and venture capital investments - there is a disproportionate payoff to gain from a rare event. We will see that, contrary to social-science wisdom, almost no discovery, no technologies of note, came from design and planning - they were just Black Swans. The strategy fir the discoverers and entrepreneurs is to rely less on top-down planning and focus on maximum tinkering and recognizing opportunities when they present themselves. So I do disagree with the followers of Marx and Adam Smith: the reason free markets work is because they allow people to be lucky, thanks to aggressive trial and error, not by giving rewards or "incentives" for skill. The strategy is, then, to tinker as much as possible and try to collect as many Black Swan opportunities as you can." P:xxv
"It is the same logic reversal we saw earlier with the value of what we don't know; everybody knows that you need more prevention than treatment, but few reward acts of prevention. We glorify those who left their names in history books at the expense of those contributors about who our books are silent. We humans are not just a superficial race (this may be curable to some extent); we are very unfair one" P:xxviii
"These kinds of discontinuities in the chronology of events did not make the historian's profession too easy: the studious examination of the past in the greatest of detail does not teach you much about the mind of History; it only gives you the illusion of understanding it.
History and societies do not crawl. They make jumps. They go from fracture to fracture, with a few vibrations in between. Yet we (and historians) like to believe in the predictable, small incremental progression. " P:11
"While we have a highly unstable memory, a diary provides indelible facts recorded more or less immediately; it thus allows the fixation of an unrevised perception and enables us to later study events in their own context. Again, it is the purported method of description of the event, not its execution, that was important." P:13
"Furthermore, I believe that the big transition in social life came not with the gramophone, but when someone had the great but unjust idea to invent the alphabet, thus allowing us to store information and reproduce it. It accelerated further when another inventor had the even more dangerous and iniquitous notion of starting a printing press, thus promoting texts across boundaries and triggering what ultimately grew into a winner-take-all ecology. Now, what was so unjust about the spread of books? The alphabet allowed stories and ideas to be replicated with high fidelity and without limit, without any additional expenditure of energy on the author's part for the subsequent performances. He didn't even have to be alive for them - death is often a good career move for an author. This implies that those who, for some reason, start getting some attention can quickly reach more minds than others and displace the competitors from the bookshelves. In the days of bards and troubadours, everyone had an audience. A storyteller, like a baker or a coppersmith, had a market, and the assurance that none from far away could dislodge him from his territory. Today, a few take almost everything; the rest, next to nothing." P:30
"... Subjects were asked which questions to ask to find out whether a person was
extroverted or not, purportedly for another type of experiment. It was established that subjects supplied mostly questions for which a "yes" answer would support the hypothesis.
But there are exceptions. Among them figure chess grand masters, who, it has been shown, actually do focus on where a speculative move might be weak; rookies, by comparison, look for confirmatory instances instead of falsifying ones. But don't play chess to practice skepticism. Scientists believe that it is the search for their own weaknesses that makes them good chess players, not the practice of chess that turns them into skeptics." P:59
"The confirmation problem pervades our modern life, since most conflicts have at their root the following mental bias: when Arabs and Israelis watch news reports they see different stories in the same succession of events. Likewise, Democrats and Republicans look at different parts of the same data and never converge to the same opinions. Once your mind is inhabited with a certain view of the world, you will tend to only consider instances proving you to be right. Paradoxically, the more information you have, the more justified you will feel in your views." P:59
"The [Narrative] fallacy is associated with our vulnerability to overinterpretation and our predilection for compact stories over raw truths. It severely distorts our mental representation of the world; it is particularly acute when it comes to the rare event." P:63
"Explanations bind facts together. They make them all the more easily remembered; they help them make more sense. Where this propensity go wrong is when it increases our impression of understanding." P:64
"For me, one such antilogic came with the discovery - thanks to the literature on cognition - that, counter to what everyone believes, not theorizing is an act - that theorizing can correspond to the absence of willed activity, the "default" option. It takes considerable effort to see facts (and remember them) while withholding judgment and resisting explanations." P:64
"... we have more physiological evidence of our ingrained pattern seeking, thanks to our growing knowledge of the role of neurotransmitters, the chemicals that are assumed to transport signals between different parts of the brain. It appears that pattern perception increases along with the concentration in the brain of the chemical dopamine. Dopamine also regulates moods and supplies an internal reward system in the brain (not surprisingly, it is found in slightly concentrations in the left side of the brains of right-handed persons than on the right side). A higher concentration of dopamine appears to lower skepticism and result in greater vulnerability to pattern detection; an injection of L-dopa, a substance used to treat patients with Parkinson's disease, seems to increase such activity and lowers one's suspension of belief. The person becomes vulnerable to all manner of fads, such as astrology, superstitions, economics, and tarot-card reading. " P:67
"We, members of the human variety of primates, have a hunger for rules because we need to reduce the dimension of matters so they can get into our heads... The more random the information is, the greater the dimensionality, and thus the more difficult to summarize. The more you summarize, the more order you put in, the less randomness. Hence the same condition that makes us simplify pushes us to think that the world is less random than it actually is.
And the Black Swan is what we leave out of simplification.
Both the artistic and scientific enterprises are the product of our need to reduce dimensions and inflict some order on things. Think of the world around you, laden with trillions of details. Try to describe it and you will find yourself tempted to weave a thread into what your are saying. A novel, a story, a myth, or a tale, all have the same function: they spare us from the complexity of the world and shield us from its randomness. Myths impart order to the disorder of human perception and the perceived "chaos of human experience." P:69
"But memory and the arrow of time an get mixed up. Narrativity can viciously affect the remembrance of past events as follows: we will tend to more easily remember those facts from our past that fit a narrative, while we tend to neglect other that do not appear to play casual role in that narrative. Consider that we recall events in our memory all the while knowing the answer of what happened subsequently. It is literally impossible to ignore posterior information when solving a problem. This simple inability to remember not the true sequence of events but a reconstructed one will make history appear in hindsight to be far more explainable than it actually was - or is." P:70
"We learn from repetition - at the expense of events that have nothappened before. Even that are nonrepeatable are ignored before their occurrence, and overestimated after (for a while). After a Black Swan, such as September 11, 2011, people expect it to recur when in fact the odds of that happening have arguably been lowered. We like to think about specific and known Black Swans when in fact the very nature of randomness lies in it abstraction. As I said in the Prologue, it is the wrong definition of God.
The economist Hyman Minsky sees the cycles of risk taking in the economy as following a pattern: stability and absence of crises encourage risk taking, complacency, and lowered awareness of the possibility of problems. Then a crises occurs, resulting in people being shell-shocked and scared of investing their resources. Strangely, both Minsky and his school, dubbed Post-Keynesian, and his opponents, the libertarian "Austrian" economists, have the same analysis, except that the first group recommends governmental intervention to smooth out the cycle, while the second believes that civil servants should not be trusted to deal with such matters." P:78
System 1: The experiential one, is effortless, automatic, fast, opaque (we do not know we are using it), parallel-processed. It is what we call "intuition".
System 2: The cognitive one, is what we call thinking. It is what you use in a calssroom, as it is effortful, reasoned, slow, logical, serial, progressive, and self-aware (you can follow the steps of your reasoning).
"Emotions are assumed to be the weapon System 1 uses to direct us and force us to act quickly." P:82
"Much of the trouble with human nature resides in our inability to use much of System 2, or to use it in a prolonged way without having to take a long beach vacation. In addition, we often just forget to use it." P:82
"Assume that ... your activities depend on a Black Swan surprise... Intellectual, scientific, and artistic activities belong to the province of Extremistan, where there is a severe concentration of success, with a very small number of winner claiming a large share of the pot...
Acknowledging the role of this concentration of success, and acting accordingly, causes us to be punished twice: we live in a society where the reward mechanism is based on the illusion of the regular; our hormonal reward system also needs tangible and steady results. It too thinks that the world is steady and well behaved - it falls for the confirmation error. The world has changed too fast for our genetic makeup. We are alienated from out environment." P:85
"Many people labor in life under the impression that they are doing something right, yet they may not show solid results for a long time. They need a capacity for continuously adjourned gratification to survive a steady diet of peer cruelty without becoming demoralized. They look like idiots to their cousins, they look like idiots to their peers, they need courage to continue. No confirmation comes to them, no validation, no fawning students, no Nobel, no Shnobel. "How was your year?" brings them a small but containable spasm of pain deep inside, since almost all of their years will seem wasted to someone looking at their life from the outside. Then bang, the lumpy event comes that brings the grand vindication. Or it may never come." P:87
"Making $1 million in one year, but nothing in the preceding nine, does not bring the same pleasure as having the total evenly distributed over same period, that is, $100000 every year for ten years in a row. The same applies to the inverse order - making bundle the first year, then nothing for the remaining period. Somehow, your pleasure system will be saturated rather quickly, and it will not carry forward the hedonic balance like a sum on a tax return. As a matter of fact, your happiness depends far more on the number of instances of positive feelings, what psychologists call "positive affect," than on their intensity when they hit. In other words, good news is good news first; how good matters rather little. So to have a pleasant life you should spread these small "affects" across time as evenly as possible." P:91
"Let us separate the world into two categories. Some people are like the turkey, exposed to a major blowup without being aware of it, while others play reverse turkey, prepared for big events that might surprise others. In some strategies and life situations, you gamble dollars to win a succession of pennies while appearing to be winning all the time. In others, you risk a succession of pennies to win dollars. In other words, you bet either that the Black Swan will happen or that it will never happen, two strategies that require completely different mind-sets." P:96
"Humans will believe anything you say provided you do not exhibit the smallest shadow of diffidence; like animals, they can detect the smallest crack in your confidence before you express it." P:98
"Numerous studies of millionaires aimed at figuring out the skills required for hotshotness follow the following methodology. They take a population of hotshots, those with big titles and big jobs, and study their attributes. They look at what those big guns have in common: courage, risk taking, optimism, and so on, and infer that these traits, most notably risk taking, help you to become successful. You should also probably get the same impression if you read CEO's ghostwritten autobiographies or attended their presentations to fawning MBA students.
Now take a look at the cemetery. It is quite difficult to do so because people who fail do not seem to write memoirs, and, if they did, those business publishers I know would not even consider giving them the courtesy of a returned phone call. Readers will not pay $26.95 for a story of failure, even if you convince them that it had more useful tricks than a story of success. The entire notion of biography is grounded in the arbitrary ascription of a casual relation between specified traits and subsequent events. Now consider the cemetery, The graveyard of failed persons will be full of people who shared the following traits: courage, risk taking, optimism, et cetera. Just like the population of millionaires. There may be some differences in skills, but what truly separates the two is for the most part a single factor: luck, Plain luck." P:105
"A life saved is a statistic; a person hurt is an anecdote. Statistics are invisible; anecdotes are salient. Likewise, the risk of a Black Swan is invisible.*
*Silence evidence can actually bias matters to look less stable and riskier than they actually are. Take cancer. We are in the habit of counting survival rates from diagnosed cancer cases - which would over estimate the danger from cancer. Many people develop cancer that remains undiagnosed, and go on to live a long and comfortable life, then die of something else, either because the cancer was not lethal or because it went into spontaneous remission. Not counting these cases biases the risks upward." P:112
"The reference point argument is as follows: do not compute odds from the vantage point of the winning gambler (or the lucky Casanova, or the endlessly bouncing back New York City, or the invincible Carthage), but from all those who started in the cohort. Consider once again the example of the gambler. If you look at the population of beginning gamblers taken as a whole, you can be close to certain that one of them (but you do not know in advance which one) will show stellar results just by luck. So, from the reference point of the beginning cohort, this is not a big deal. But from the reference point of the winner (and, who does not, and this is key, take the losers into account), a long string of wins will appear to be too extraordinary an occurrence to be explained by luck. Note that a "history" is just a series of nubers through time. The numbers can represent degrees of wealth, fitness, weight, anything." P:119
"Randomness and uncertainty are abstractions. We respect what happened, ignoring what could have happened. In other words, we are naturally shallow and superficial - and we do not know it. This is not psychological problem; it comes from the main property of information. The dark side of the moon is harder to see; beaming light on it costs energy. In the same way beaming light on the unseen is costly in both computational and mental effort." P:132
"I propose if you want a simple step to a higher form of life, as distant from the animal as you can get, then you may have to denarrate, that is, shut down the television set, minimize time spent reading newspapers, ignore the blogs. Train your reasoning abilities to control your decisions; nudge System 1 (the heuristic or experiential system) out of the important ones. This insulation from the toxicity of the world will have an additional benefit: it will improve your well-being. Also, bear in mind how shallow we are with probability, the mother of all abstract notions. You do not need to do much more to gain a deeper understanding of things around you. Above all, learn to avoid "tunneling.""
"Show two groups of people a blurry image of a fire hydrant, blurry enough for them not to recognize what it is. For one group, increase the resolution slowly, in ten steps. For the second, do it faster, in five steps. Stop at a point where both groups have been presented an identical image and ask each one of them to identify what they see. The members of the group that saw fewer intermediate steps are likely to recognize the hydrant much faster. Moral? The more information you give someone, the more hypothesis they will formulate along the way, and the worse off they will be. They see more random noise and mistake it for information." P:144
"The problem is that our ideas are sticky: Once we produce a theory, we are not likely to change our minds - so those who delay developing their theories are better off. When you develop you opinions on the basis of weak evidence, you will have difficulty interpreting subsequent information that contradicts these opinions, even if this new information is obviously more accurate. Two mechanisms are at play here: the confirmation bias ..., and belief perseverance. Remember that we treat ideas like possessions, and it will be hard for us to part with them." P:144
"The fire hydrant was first done in the sixties, and replicated several times sense. I have also studied this effect using the mathematics of information: the more detailed knowledge one gets of empirical reality, the more one will see the noise ( i.e. the anecdote) and mistake it for actual information. Remember that we are swayed by the sensational. Listening to the news on the radio every hour is far worse than reading a weekly magazine, because the longer interval allows information to be filtered a bit." P:144
"Finally in another telling experiment, the psychologist Paul Slovic asked bookmakers to select from eighty-eight variables in past horse races those that they found useful in computing the odds. These variables included all manner of statistical information about past performances. The bookmakers were given the ten most useful variables, then asked to predict the outcome of races. Then they were given ten more and asked to predict again. The increase in the information set did not lead to an increase in their accuracy; their confidence in their choices, on the other hand, went up markedly. Information proved to be toxic." P:145
"On one hand, we are shown by a class of expert-busting researchers such as Paul Meehl and Robyn Dawes that the "expert " is the closest thing to a fraud, performing no better than a computer using a single metric, their intuition getting in the way and blinding them. (As an example of a computer using a single metric, the ratio of liquid assets to debt fares better than the majority of credit analysts.)" P:146
"We can already see the difference between "know how" and "know-what". The Greeks made a distinction between techne and episteme." P:146
"In a study comparing them [security analysts] with weather forecasters, Tadeusz Tyszka and Piotr Zielonka documents that the analysts are worse predicting, while having a greater faith in their own skills. Somehow, the analysts' self-evaluation did not decrease their error margin after their failure to forecast." P:150
"I will go now into more general defects uncovered by this example. These "experts" were lopsided: on the occasions when they were right, they attributed it to their own depth of understanding and expertise; when wrong, it was either the situation that was to blame, since it was unusual, or, worse, they did not recognize that they were wrong and spun stories around it. They found it difficult to accept that their grasp was a little short. But this attribute is universal to all our activities: there is something in us designed to protect our self-esteem.
We humans are the victims of an asymmetry in the perception of random events. We attribute our successes to our skills, and our failures to external events outside our control, namely to randomness. We feel responsible for the good stuff, but not for the bad." P:152
"Hedgehogs, because of the narrative fallacy, are easier for us to understand - their ideas work in sound bites. Their category is over represented among famous people; ergo famous people are on average worse at forecasting than the rest of the predictors." P:153
"Similarly, ask someone to provide you with the last 4 digits of his social security number. Then ask him to estimate the number of dentists in Manhattan. You will find that by making him aware of the four-digit number, you elicit an estimate that is correlated with it.
We use reference points in our heads, say sales projections, and start building beliefs around them because less mental effort is needed to compare an idea to a reference point than to evaluate it in the absolute (system 1 at work!). We cannot work without a point of reference.
So the introduction of a reference point in a forecaster's mind will work wonders. This is no different from starting point in a bargaining episode. This is no different from a starting point in a bargaining episode: you open with high number ("I want a million for this house"); the bidder will answer "only eight-fifty" - the discussion will be determined by that initial level." P: 158
"Like many biological variables, life expectancy is from Mediocristan, that is, it is subject to mild randomness. It is not scalable, since the older we get, the less likely we are to live. In a developed country a newborn female is expected to die at around 79, according to insurance tables. When she reaches her 79th birthday, her life expectancy, assuming that she is in typical health, is another 10 years. At the age 90, she should have another 4.7 years to go. At the age of 100, 2.5 years. At the age of 119, if she miraculously lives that long, she should have about nine months left. As she lives beyond the expected date of death, the number of additional years to go decreases. This illustrates the major property of random variables related to the bell curve. The conditional expectation of additional life drops as a person gets older.
With human projects and ventures we have another story. These are often scalable, as I said in Chapter 3. With scalable variables, the ones from Extremistan, you will witness the exact opposite effect. Let's say a project us expected to terminate in 79 days, the same expectation in days as the newborn female has in years. On the 79th day, if the project is not finished, it will be expected to take another 25 days to complete. But on the 90th day, if the project is still not completed, it should have about 58 days to go. On the 100th, it should have 89 days to go. On the 119th, it will be expected to need an extra 1590 days. As you see, the longer you wait, the longer you will be expected to wait." P:159
" P:159
"The classical model of discovery is as follows: you search for what you know (say, a new way to reach India) and find something you didn't know was there (America).
If you think that the inventions we see around us came from someone sitting in a cubicle and concocting them according to a timetable, think again: almost everything of the moment is the product of serendipity. The term serendipity was coined in a letter by the writer Hugh Walpole, who derived it from a fairy tale, "The Three Princes of Serendip." These princes "were always making discoveries by accident or sagacity, of thins which they were not in quest of." P:166
"This multiplicative difficulty leading to the need for greater and greater precision in assumptions can be illustrated with the following simple exercise concerning the prediction of the movement of billiard balls on a table.I use the example as computed by the mathematician Michael Berry. If you know a set of basic parameters concerning the ball at rest, can compute the resistance of the table (quite elementary), and can gauge the strength of the impact, then it is rather easy to predict what would happen at the first hit. The second impact becomes more complicated, but possible; you need to be more careful about your knowledge of the initial states, and more precision is called for. The problem is that to correctly compute the ninth impact, you need to take into account the gravitational pull of someone standing next to the table (modestly, Berry's computations use a weight of less than 150 pounds). And to compute the fifty-sixth impact, every single elementary particle of the universe needs to be present in your assumptions! An electron at the edge of the universe, separated from us by 10 billion light-years, must figure in the calculations, since it exerts a meaningful effect on the outcome. Now, consider the additional burden of having to incorporate predictions about where these variables will be in the future. Forecasting the motion of a billiard ball on a pool table requires knowledge of the dynamics of the entire universe, down to every single atom! We can easily predict the movements of large objects like planets (though not too far into the future), but the smaller entities can be difficult to figure out - and these are so many more of them." P:178
"Corporations survive not because they have made good forecasts, but because, like the CEO visiting Wharton I mentioned earlier, they may have been the lucky ones. And, like a restaurant owner, they may be hurting themselves, not us - perhaps helping us subsidizing our consumption by giving us gods in the process, like cheap telephone calls to the rest of the world funded by the overinvestment during the dotcom era. We consmers can let them forecast all they want if that's what is necessary for them to get into business. Let them go hang themselves if they wish." P:180
"As individuals we should love free markets because operators in them can be as incompetent as they wish" P:181
"It has been more profitable for us to bind together in the wrong direction than to be alone in the right one." P:192
"The Black Swan asymmetry allows you to be confident about what is wrong, not about what you believe is right." P:192
"Psychologists have studied this kind of misprediction with respect to both pleasant and unpleasant events. We overestimate the effects of both kinds of future events on our lives." P:195
"The lesson for the small is: be human! Accept that being human involves some amount of epistemic ignorance in running your affairs. Do not be ashamed of that. Do not try to always withhold judgement - opinions are the stuff of life. Do not try to avoid predicting - yes, after this diatribe about prediction I am not arguing you to stop being a fool. Just be a fool in the right places.
What you should avoid is unnecessary dependence on large-scale harmful predictions - those and only those. Avoid the big subjects that might hurt your future: be fooled in small matters, not in the large. Do not listen to economic forecasters or to predictors in social science (they are mere entertainers), but do make your own forecast for the picnic.By all means, demand certainty for the next picnic; but avoid government social security forecasts for the year 2040.
Know how to rank beliefs not according to their plausibility but by the harm they might cause." P:203
"Indeed, we have psychological and intellectual difficulties with trial and error, and with accepting that series of small failures are necessary in life. My colleague Mark Spitznagel understood that we humans have a mental hang-up about failures: "You ned to love to lose" was his motto. In fact, the reason I felt immediately at home in America is precisely because American culture encourages the process of failure, unlike the cultures of Europe and Asia where failure is met with stigma and embarrassment. America's speciality is to take these small risks for the rest of the world, which explains this country's disproportionate share in innovations. Once established, an idea or a product is later "perfected" over there." P:204
"People are often ashamed of losses, so they engage in strategies that produce very little volatility but contain the risk of a large loss - like collecting nickels in front of steamroller. In Japanese culture, which is ill-adapted to randomness and badly equipped to understand that bad performance can come from bad luck, losses can severely tarnish someone's reputation. People hate volatility, thus engage in strategies exposed to blowups, leading to occasional suicides after big losses." P:204
"I am trying here to generalize to real life the notion of the "barbell" strategy I used as a trader, which is as follows. If you know that you are vulnerable to prediction errors, and if you accept that most "risk measures" are flawed, because of the Black Swan, then your strategy is to be as hyperconservative and hyperagressive as you can be instead of being mildly aggressive or conservative. Instead of putting your money in "medium risk" investments (how do you know is it medium risk? by listening to tenure-seeking "experts"?), you need to put portion, say 85 or 90 percent, in extremely safe instruments, like Treasury bills - as safe a class of instruments as you can manage to find in this planet. The remaining 10 to 15 percent you can put in extremely speculative bets, as leveraged as possible (like options), preferably venture capital-style protfolios. That way you do not depend on errors of risk management; no Black Swan can hurt you at all, beyond your "floor", the nest egg that you have in maximally safe investments. Or, equivalently, you can have a speculative protfolio and insure it if possible against losses of more than, say, 15 percent. You are "clipping" your incomputable risk, the one that is harmful to you. Instead of having medium risk, you have high risk on one side and no risk on the other. The average will be medium risk but constitute a positive exposure to the Black Swan. More technically, this can be called a "convex" combination." P:206
"Middlebrow thinkers sometimes make the analogy of such strategy with that of collecting "lottery tickets." It is plain wrong. First, lottery tickets do not have a scalable payoff; there is a known upper limit to what they can deliver. The ludic fallacy applies here - the scalability of real-life payoffs compared to lottery ones makes the payoff unlimited or of unknown limit. Secondly, the lottery tickets have known rules and laboratory-style well-presented possibilities; here we do not know the rules and can benefit from this additional uncertainty, since it cannot hurt you and can only benefit you." P:208
"Seize any opportunity, or anything that looks like opportunity. They are rare, much rarer than you think. Remember that positive Black Swans have a necessary first step: you need to be exposed to them. Many people do not realize they are getting a lucky break in life when they get it. If a big publisher (or a big art dealer or a movie executive or a hotshot banker or a big thinker) suggests and appointment, cancel anything you have planned: you may never see such a window open up again. I am sometimes shocked at how little people realize that these opportunities fo not grow on trees. Collect as many free non-lottery tickets (those with open-ended payoffs) as you can, and, once hey start paying off, do not discard them. Work hard, not in grunt work, but in chasing such opportunities and maximizing exposure to them. This makes living in big cities invaluable because you increase the odds of serendipitous encounters - you gain exposure to the envelop of serendipity. The idea of settling in a rural area on grounds that one has good communications "in the age of the Internet" tunnels out of such sources of positive uncertainty. Diplomats understand that very well: casual chance discussions at cocktail parties usually lead to big breakthroughs - not dry correspondence of telephone conversations. Go to parties! If you're a scientist, you will chance upon a remark that might spark new research. And if you are autistic, send your associates to these events" P:208
"Indeed, the notion of asymmetric outcome is the central idea of this book: I will never get to know the unknown since, by definition, it is unknown. However, I can always guess how it might affect me, and I should base my decisions around that." P:210
"I don't know the odds of an earthquake, but I can imagine how San Francisco might be affected by one. This idea that in order to make a decision you need to focus on the consequences (which you can know) rather than the probability (which you can't know) is the central idea of uncertainty." P:211
"But the role of luck is missing in Rosen's beautiful argument. The problem here is the notion of "better," this focus on skills are leading to success. Random outcomes, or an arbitrary situation, can also explain success, and provide the initial push that leads to a winner-take-all result. A person can get slightly ahead for entirely random reasons, because we like to imitate one another, we will flock to him. The world of contagion is so underestimated!" P:216
"More than a decade before Rosen, the sociologist of science Robert K. Merton presented his idea of the Matthew effect, by which people take from the poor to give to the Rich. He looked at the performance of scientists and showed how an initial advantage follows someone through life." P:216
"Note that art, because of its dependence on word of mouth, is extremely prone to these cumulative-advantage effects." P:218
"In sum, the long tail is a by-product of Extremistan that makes it some what less unfair: the world is made no less unfair for the little guy, but it now becomes extremely unfair for the big man. Nobody is truly established. The little guy is very subversive." P:225
"There is, inevitably, a mounting tension between our society, full of concentration, and our classical idea of aurea mediocritas, the golden mean, so it is conceivable that efforts may be made to reverse such concentration. We live in a society of one person, one vote, where progressive taxes have been enacted precisely to weaken the winners. Indeed, the rules of society can be easily rewritten by those at the bottom of the pyramid to prevent concentration from hurting them. But it does not require voting to do so - religion could often soften the problem. Consider that before Christianity, in many societies the powerful had many wives, thus preventing those at the bottom from accessing wombs, a condition that is not too different from the reproductive exclusivity of alpha males in many species. But Christianity reversed this, thanks to the one man-one woman rule. Later, Islam came to limit the number of wives to four. Judaism, which had been polygenic, became monogamous in the Middle Ages. One can say that such a strategy has been successful - the situation of tightly monogamous marriage (with no official concubine, as in the Greco-Roman days), even when practiced the "French way," provides social stability since there is no pool of angry, sexually deprived men at the bottom fomenting a revolution just so they can have the chance to mate." P:227
"What is poorly understood, or denied (owing to its unsettling implications), is the absence of a role for the average in intellectual production. The disproportionate share of the very few in intellectual influence is often more unsettling than the unequal distribution of wealth - unsettling because, unlike the income gap, no social policy can eliminate it. Communism can conceal or compress income discrepancies, but it could not eliminate the superstar system in intellectual life" P:227
"I'll summarize here and repeat the arguments previously made throughout the book. Measures of uncertainty that are based on the bell curve simply disregard the possibility, and the impact of sharp jumps or discontinuities and are, therefore, inapplicable in Extremistan. Using them is like focusing on the grass and missing out on the (gigantic) trees. Although unpredictable large deviations are rare, they cannot be dismissed as outliers because, cumulatively, their impact is so dramatic." P:236
"We can make good use of the Gaussian approach in variables for which there is a rational reason for the largest not too be too far away from the average. If there is gravity pulling numbers down, or if there are physical limitations preventing very large observations, we end up in Mediocristan. If there are strong forces of equilibrium, then again you can use the Gaussian approach." P:236
"Casino operators understand this well, which is why they never (if they do things right) lose money. They simply do not let one gambler make a massive bet, instead preferring to have plenty of gamblers make a series of bets of limited size." P:238
"To see how meaningless correlation can be outside of Mediocristan, take a historical series involving two variables that are patently from Extremistan, such as the bond and the stock markets, or two securities prices, or two variables like, say, changes in book sales of children's books in the United States, and fertilizer production in China; or real-estate prices in New York City and returns of the Mongolian stock market. Measure correlation between the pairs of variables in different subperiods, say, for 1994, 1995, 1996, etc. The correlation measure will be likely to exhibit severe instability; it will depend on the period for which it was computed. Yet people talk about correlation as if it were something real, making it tangible, investing it with a physical property, reifying it. " P:239
"If you're dealing with qualitative inference, such as in psychology or medicine, looking for yes/no answers to which magnitudes don't apply, then you can assume you're in Mediocristan without serious problems. The impact of the improbable cannot be too large. You have cancer or you don't, you are pregnant or you are not, et cetera. Degrees of deadness or pregnancy are not relevant (unless you are dealing with epidemics). But if you are dealing with aggregates, where magnitudes do matter, such as income, yor wealth, return on a portfolio, or book sales, then you will have a problem and get the wrong distribution if you use the Gaussian, as it does not belong there. Only single number can disrupt all your averages; one single loss can eradicate a century of profits." P:244
"As the reader can see, the main point of the Gaussian bell curve is, as I have been saying, that most observations hover around the mediocre, the mean, while the odds of a deviation decline faster and faster (exponentially) as you move away from the mean. If you need to retain one single piece of information, just remember this dramatic speed of decrease in the odds as you move away from the average. Outliers are increasingly unlikely. You can safely ignore them." P:250
"First central assumption: the flips are independent of one another. The coin has no memory. The fact that you got heads or tails on the previous flip does not change the odds of your getting heads or tails on the next one. The fact that you got heads or tails on the previous flip does not change the odds of your getting heads or tails on the next one. You do not become a "better" coin flipper over time. If you introduce memory, or skills in flipping, the entire Gaussian business becomes shaky. P:250"
"One can almost always ferret out predecessors for any thought. You can always find someone who worked on a part of your argument and use his contributions as your backup." P:256
"In the end it is those who derive consequences and seize the importance of the ideas, seeing their real value, who win the day. They are the ones who can talk about the subject." P:256
"This regress does not occur if you assume beforehand that the distribution is Gaussian. It happens that, for some reason, the Gaussian yields its properties rather easily. Extremistan distributions do not do so. So selecting the Gaussian while invoking some general law appears to be convenient. The Gaussian is used as a default distribution for that very reason. As I keep repeating, assuming its application beforehand may work with small number of fields such as crime statistics, mortality rates, matters from Mediocristan. But not for historical data of unknown attributes and not for matters from Extremistan." P:269
"If the world of finance was Gaussian, an episode such as the crash (more than 20 standard deviations) would take place every several billion lifetimes of the universe. According to the circumstances of 1987, people accepted that rare events take place and are the main source of uncertainty. They were just unwilling to give up on the Gaussian as a central measurement tool - "Hey, we have nothing else." People want a number to anchor on. Yet the two methods are logically incompatible." P:276
"Merton wrote that before portfolio theory, finance was "a collection of anecdotes, rules of thumb, and manipulation of accounting data." Portfolio theory allowed "the subsequent evolution from this conceptual postpouri to a rigorous economic theory." P:278
"A theory is like medicine (or government): often useless, sometimes necessary, always self serving, and on occasion lethal. So it need to be used with care, moderation, and close adult supervision." P:285
"The ludic fallacy is present in the following chance setups: random walk, dice throwing, coin flipping, the infamous digital "heads or tails" expressed as 0 or 1, Brownian motion, and similar examples. These setups generate a quality of randomness that does not even qualify as randomness - protorandomness would be more appropriate designation. At their core, all theories built around the ludic fallacy ignore a layer of uncertainty. Worse, their proponents do not know it!" P:287
"People who worry about pennies instead of dollars can be dangerous to society. They mean well, but, invoking my Bastiat argument of Chapter 8, they are a threat to us. They are wasting our studies of uncertainty by focusing on the insignificant. Our resources (both cognitive and scientific) are limited, perhaps too limited. Those who distract us increase the risk of Black Swans." P:288
"(I also have to confess that I do not worry a lot, I try to worry about matters I can do something about). I worry less about embarrassment than about missing an opportunity." P:296
"Missing the train is only painful if you run after it! Likewise, not matching the idea of success others expect from you is only painful if that's what you are seeking." P:297
"The corollary is obvious: since there is nothing new about the crises of 2008, we will not learn from it and we will make the same mistake in the future. And the evidence is there at the time of writing: the IMF continues to issue forecasts (not realizing tjat previous ones did not work and that the poor suckers relying on them are - once again - going to get in trouble." P:322
"..So where is he getting this "once in ten thousand years" probability? Certainly not from personal experience; certainly not from the records of Lehman Brothers - his firm had not been around for 10000 years, and of course it didn't stay around for another 10000 years, as it went under right after our debate. The more remote the event, the less we can get empirical data (assuming generously that the future will resemble the past) and the more we need to rely on theory.
Consider that the frequency of the rare events cannot be estimated from empirical observation for the very reason that they are rare. We thus need a prior model representation for that; the rarer the event, the higher the error in estimation from standard inductive methods (say, frequency sampling from counting past occurrences), hence the higher the dependence on a priori representation that extrapolates into the space of low probability events (which necessarily are not seen often).
But even outside of small probabilities, the a priori problem is always present. It seems salient with respect to rare events, but it pervades probabilistic knowledge. I will present two versions I have been working on with two collaborators, Avital Piple, a philosopher of science (he walks fast), and Raphael Douady, a mathematician (he is sometimes a good walker, when he is not busy).
Epimenides the Cretan
Avital Pilpel and I expressed the regress argument as follows, as the epistemic problem of risk management, but the argument can be generalized to any form of probabilistic knowledge. It is a problem of self-reference by probability measures.
We can state it in the following way. If we need data to obtain a probability distribution to gauge knowledge about the future behavior of the distribution from its past results, and if, at the same time, we need a probability distribution to gauge data sufficiency and whether or not it is predictive of the future, then we face a severe regress loop.This is a problem of self-reference akin to that of Epimenides the Cretan stating whether of not Cretans are liars. Indeed, it is too uncomfortably close to the Epimenides situation, since a probability distribution is used to assess the degree of truth but cannot reflect on its own degree of truth and validity. And, unlike many problems of self-references, those related to risk assessment have severe consequences. The problem is more acute with small probabilities.
An Undecidability Theorem
This problem of self-reference, published with Pilpel after the Black Swan, went unnoticed as such. So Raphael Douady and I re-expressed the philosophical problem mathematically, and it appears vastly more devastating in it's practical implications than the Godel problem.
Raphael is, among the people I know, perhaps the man with the greatest mathematical erudition - he may have more mathematical culture than anyone in modern times, except perhaps for his late father, Adrien Douady.
At the time of writing, we may have produced a formal proof using mathematics, and a branch of mathematics called "measure theory" that was used by the French to put rigor behind the mathematics of probability. The paper is provisionally called "Undecidability: On the inconsistency of estimating probabilities form a sample without binding a priori assumptions on the class of acceptable probabilities."
It's the Consequences...
Further, we in real life do not care about simple, raw probability ( whether an event happens or does not happen); we worry about consequences (the size of the event; how much total destruction of lives or wealth, or other losses, will come from it; how much benefit a beneficial event will bring). Given that the less frequent the event, the more severe the consequences (just consider the the hundred-year floor is more severe, and less frequent, than the ten-year flood; the best seller of the decade ships more copies than the [best seller] of the year), our estimation of the contribution of the rare event is going to be massively faulty (contribution is probability times effet; multiply that by estimation error); and nothing can remedy it.
So the rarer the event, the less we know about its role - and the more we need to compensate for that deficiency with an extrapolative, generalizing theory. It will lack in rigor in proportion to claims about the rarity of the event. Hence theoretical and model error are more consequential in the tails; and, the good news, some representations are more fragile than others.
I showed that this error is more severe in Extremistan, where rare events are more consequential, because of a lack of scale, or a lack of asymptotic ceiling for the random variable. In Mediocristan, by comparison, the collective effect of regular events dominates and the exceptions are rather inconsequential - we know their effect, and it is very mild because one can diversify thanks to the "law of large numbers." Let me provide once again an illustration of Extremistan. Less than 0.25 percent of all the companies listed in the world represent around half the market capitalization, a less than minuscule percentage of novels on the planet accounts for approximately half fiction sales, less than 0.1 percent of drugs generate a little more than half the pharmaceutical industry's sales and less than 0.1 percent of risky events will cause at least half the damages and losses." P:352
"But the problem gets more interesting in some domains. Recall the Casanova problem in Ch8. For environments that tend to produce negative Black Swans, but not positive Black Swans (these environments are called negatively skewed), the problem of small probabilities is worse. Why? Clearly, catastrophic events will be necessarily absent from the data, since the survivorship of the variable itself will depend on such effect. Thus such distributions will let the observer become prone to overestimation of stability and underestimation of potential volatility and risk.
This point - that things have a bias to appear more stable and less risky in the past, leading us to surprises - needs to be taken seriously, particularly in the medical field. The history of epidemics, narrowly studied, does not suggest the risks of the great plague to come that will dominate the planet. Also I am convinced tat in doing what we are t the environment, we greatly underestimate the potential instability we will experience somewhere from the cumulative damage we have done to nature.
One illustration of this point is playing out just now. At the time of writing, the stock market has proved much, much riskier than innocent retirees were led to believe from historical discourses showing a hundred years of data. It is down to close to 23 percent for the decade ending in 2010, while the retiress were told by finance charlatans that is was expected to rise by around 75 percent of that time span. This has bankrupted many pension plans ( and the largest car company in the world), for they truly bought into that "empirical" story - and of course it has caused many disappointed people to delay their retirement. Consider that we are suckers and will gravitate toward those variables that are unstable but that appear stable.
Preasymptotics. Let us return to Platonicity with a discussion of presymptotics, what happens in the short term. Theories are of, of course, a bad thing to start with, but they can be worse in some situations when they were derived in idealized situations, the asymptote, but are used outside the asymptote (its limit, say infinity or the infinitesimal). Mandelbrot and I showed how some asymptotic properties do work well preasymptotically in Mediocristan, which is why casinos do well; matters are different in Extremistan.
Most statistical education is based on these asymptotic, Platonic properties, yet we live in the real world, which rarely resembles the asymptote. Statistical theorists know it, or claim to know it, but not your regular user of statistics who talks about "evidence" while writing papers. Furthermore, this compounds what I called the ludic fallacy: most of what students of mathematical statistics do is assume a structure similar to the closed structures of games, typically with a priori known probability. Yet the problem we have is not so much making computations once you know the probabilities, but finding the true distribution for the horizon concerned. Many of our knowledge problems come from this tension between a priori and a posteriori.
Proof in the flesh
There is no reliable way to compute small probabilities. I argued philosophically the difficulty of computing the odds of rare events. Using almost all available economic data - and I used economic data because that's where the clean data was - I showed the impossibility of computing from the data the measure of how far away from the Gaussian one was. There is a measure called kurtosis that the reader does not need to bother with, but that represents "How fat the tails are," that is, ow much rare events play a role. Well, often, with then thousand pieces of data, forty years of daily observations, one single observation represents 90 percent of the kurtosis! Sampling error is too large for any statistical inference about how non-Gaussian something is, meaning that if you miss a single number, you miss the whole thing. The instability of the kurtosis implies that a certain class of statistical measures should be totally disallowed. This proves that everything relying on "standard deviation," "variance," "least square deviation," etc. is bogus.
Further, I also showed that it is impossible to use fractals to get acceptably precise probabilities - simply because a very small change in what I called the "tail exponent" in Ch 16, coming from observation error, would make the probabilities change by a factor of 10, perhaps more.
Implication: the need to avoid exposure to small probabilities in a certain domain. We simply cannot compute them. " P:355
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"Our research shows that the way a risk is framed sharply influences people's understanding of it. If you say that, on average, investors will lose all their money every thirty years, they are more likely to invest than if you tell them they have a 3.3 percent change of losing certain amount every year." P:358
"[if you ask people] Safety statistics show that, if you fly once a year, there will be on average one crash every thousand years on this airline. All the respondents said they would [fly]. But when we changed the second so it read, "Safety statistics show that, on average, one in a thousand flight on this airline have crashed," only 70 percent said they would take the flight. In both cases, the chance of a crash is 1 in 1000; the latter formulation simply sounds more risky." P:358
"I tried to explain the problems of errors in monetary policy under non-linearities: you keep adding money with no result...until there is a hyperinflation. Or nothing. Governments should not be given toys they do not understand." P:360
"How do you live long? By avoiding death. Yet people do no realize that success consists mainly in avoiding losses, not in trying to derive profits." P:368
"Linked to this need for positive device is the preference we have to do something rather than nothing, even in cases when doing something is harmful." P:368
"The nihilism label has always been used to harm. Practitioners who were conservative and considered the possibility of letting nature do its job, or who stated the limits of our medical understanding, were until the 1960s accused of "theraputic nihilism". It was deemed "unscientific" to avoid embarking on a course of action based on an incomplete understanding of the human body - to say, "This is the limit; this is where my body of knowledge stops." It has been used against this author by intellectual fraudsters trying to sell products." P:369
"You could satisfy your illusion of control by going to the Temple of Apollo rather than seeing the doctor. What is interesting is that the ancient Mediterraneans may have understood the trade-off very well and my have accepted religion partly as a tool to tame the illusion of control.
You cannot do anything without knowledge unless you know where it stops, and the costs of using it. Post-Enlightenment science, and its daughter superstar science, were lucky to have done well in (linear) physics, chemistry, and engineering. But at some point we need to give up on elegance to focus on something that was given short shrift for a very long time: the maps showing what current knowledge and current methods do not do for us; and a rigorous study of generalized scientific iatrogenics, what harm can be caused by science (or, better, and exposition of what harm has been done by science). I find it the most respectable of pursuits." P:370
"The most obvious was to exit the Fourth Quadrant is by "truncating", cutting certain exposures by purchasing insurance, when available, putting oneself in the "barbell" situation..." P:370
"On the other hand, research ventures show a less rosy past history. A biotech company (usually) faces positive uncertainty, while a bank faces almost exclusively negative shocks." P:373
"2. No socialization of losses and privatization of gains.
Whatever may need to be bailed out should be nationalized; whatever does not need to be bailed out should be free, small, and risk-bearing. We got ourselves into the worst of capitalization and socialism. In France, in the 1980s, the socialists took over the banks. In the United States in the 2000s, the bans took over the government. This is surreal." P: 374
"4. Don't let someone making an "incentive" bonus manage a nuclear plant - or your financial risks.
Odd are he would cut every corner on safety to show "profits" from these savings while claiming to be "conservative". Bonuses don't accommodate the hidden risks of blowups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards." P:375
"Seneca is the one who taught Montaigne that to philosophize is to learn how to die. Seneca is the one who taught Nietzsche the armor fati, "love fate", which prompted Nietzsche to just shrug and ignore adversity, mistreatment by his critics, and his disease, to the point of being bored by them." P:378
"Our inability to predict in environments subjected to the Black Swan, coupled with a general lack of the awareness of this state of affairs, means that certain professionals, while believing they are experts, are in fact not. Based on their empirical record, they do not know more about their subject matter than the general population, but they are much better at narrating - or, worse, at smoking you with complicated mathematical models. They are also more likely to wear a tie.
Black Swans being unpredictable, we need to adjust to their existence (rather than naively predict them). There are so many things we can do if we focus on antiknowledge, or what we do not know. Among many other benefits, you can set yourself up to collect serendipitous Black Swans (of the positive kind) by maximizing your exposure to them. Indeed, in some domains - such as scientific discovery and venture capital investments - there is a disproportionate payoff to gain from a rare event. We will see that, contrary to social-science wisdom, almost no discovery, no technologies of note, came from design and planning - they were just Black Swans. The strategy fir the discoverers and entrepreneurs is to rely less on top-down planning and focus on maximum tinkering and recognizing opportunities when they present themselves. So I do disagree with the followers of Marx and Adam Smith: the reason free markets work is because they allow people to be lucky, thanks to aggressive trial and error, not by giving rewards or "incentives" for skill. The strategy is, then, to tinker as much as possible and try to collect as many Black Swan opportunities as you can." P:xxv
"It is the same logic reversal we saw earlier with the value of what we don't know; everybody knows that you need more prevention than treatment, but few reward acts of prevention. We glorify those who left their names in history books at the expense of those contributors about who our books are silent. We humans are not just a superficial race (this may be curable to some extent); we are very unfair one" P:xxviii
"These kinds of discontinuities in the chronology of events did not make the historian's profession too easy: the studious examination of the past in the greatest of detail does not teach you much about the mind of History; it only gives you the illusion of understanding it.
History and societies do not crawl. They make jumps. They go from fracture to fracture, with a few vibrations in between. Yet we (and historians) like to believe in the predictable, small incremental progression. " P:11
"While we have a highly unstable memory, a diary provides indelible facts recorded more or less immediately; it thus allows the fixation of an unrevised perception and enables us to later study events in their own context. Again, it is the purported method of description of the event, not its execution, that was important." P:13
"Furthermore, I believe that the big transition in social life came not with the gramophone, but when someone had the great but unjust idea to invent the alphabet, thus allowing us to store information and reproduce it. It accelerated further when another inventor had the even more dangerous and iniquitous notion of starting a printing press, thus promoting texts across boundaries and triggering what ultimately grew into a winner-take-all ecology. Now, what was so unjust about the spread of books? The alphabet allowed stories and ideas to be replicated with high fidelity and without limit, without any additional expenditure of energy on the author's part for the subsequent performances. He didn't even have to be alive for them - death is often a good career move for an author. This implies that those who, for some reason, start getting some attention can quickly reach more minds than others and displace the competitors from the bookshelves. In the days of bards and troubadours, everyone had an audience. A storyteller, like a baker or a coppersmith, had a market, and the assurance that none from far away could dislodge him from his territory. Today, a few take almost everything; the rest, next to nothing." P:30
"... Subjects were asked which questions to ask to find out whether a person was
extroverted or not, purportedly for another type of experiment. It was established that subjects supplied mostly questions for which a "yes" answer would support the hypothesis.
But there are exceptions. Among them figure chess grand masters, who, it has been shown, actually do focus on where a speculative move might be weak; rookies, by comparison, look for confirmatory instances instead of falsifying ones. But don't play chess to practice skepticism. Scientists believe that it is the search for their own weaknesses that makes them good chess players, not the practice of chess that turns them into skeptics." P:59
"The confirmation problem pervades our modern life, since most conflicts have at their root the following mental bias: when Arabs and Israelis watch news reports they see different stories in the same succession of events. Likewise, Democrats and Republicans look at different parts of the same data and never converge to the same opinions. Once your mind is inhabited with a certain view of the world, you will tend to only consider instances proving you to be right. Paradoxically, the more information you have, the more justified you will feel in your views." P:59
"The [Narrative] fallacy is associated with our vulnerability to overinterpretation and our predilection for compact stories over raw truths. It severely distorts our mental representation of the world; it is particularly acute when it comes to the rare event." P:63
"Explanations bind facts together. They make them all the more easily remembered; they help them make more sense. Where this propensity go wrong is when it increases our impression of understanding." P:64
"For me, one such antilogic came with the discovery - thanks to the literature on cognition - that, counter to what everyone believes, not theorizing is an act - that theorizing can correspond to the absence of willed activity, the "default" option. It takes considerable effort to see facts (and remember them) while withholding judgment and resisting explanations." P:64
"... we have more physiological evidence of our ingrained pattern seeking, thanks to our growing knowledge of the role of neurotransmitters, the chemicals that are assumed to transport signals between different parts of the brain. It appears that pattern perception increases along with the concentration in the brain of the chemical dopamine. Dopamine also regulates moods and supplies an internal reward system in the brain (not surprisingly, it is found in slightly concentrations in the left side of the brains of right-handed persons than on the right side). A higher concentration of dopamine appears to lower skepticism and result in greater vulnerability to pattern detection; an injection of L-dopa, a substance used to treat patients with Parkinson's disease, seems to increase such activity and lowers one's suspension of belief. The person becomes vulnerable to all manner of fads, such as astrology, superstitions, economics, and tarot-card reading. " P:67
"We, members of the human variety of primates, have a hunger for rules because we need to reduce the dimension of matters so they can get into our heads... The more random the information is, the greater the dimensionality, and thus the more difficult to summarize. The more you summarize, the more order you put in, the less randomness. Hence the same condition that makes us simplify pushes us to think that the world is less random than it actually is.
And the Black Swan is what we leave out of simplification.
Both the artistic and scientific enterprises are the product of our need to reduce dimensions and inflict some order on things. Think of the world around you, laden with trillions of details. Try to describe it and you will find yourself tempted to weave a thread into what your are saying. A novel, a story, a myth, or a tale, all have the same function: they spare us from the complexity of the world and shield us from its randomness. Myths impart order to the disorder of human perception and the perceived "chaos of human experience." P:69
"But memory and the arrow of time an get mixed up. Narrativity can viciously affect the remembrance of past events as follows: we will tend to more easily remember those facts from our past that fit a narrative, while we tend to neglect other that do not appear to play casual role in that narrative. Consider that we recall events in our memory all the while knowing the answer of what happened subsequently. It is literally impossible to ignore posterior information when solving a problem. This simple inability to remember not the true sequence of events but a reconstructed one will make history appear in hindsight to be far more explainable than it actually was - or is." P:70
"We learn from repetition - at the expense of events that have nothappened before. Even that are nonrepeatable are ignored before their occurrence, and overestimated after (for a while). After a Black Swan, such as September 11, 2011, people expect it to recur when in fact the odds of that happening have arguably been lowered. We like to think about specific and known Black Swans when in fact the very nature of randomness lies in it abstraction. As I said in the Prologue, it is the wrong definition of God.
The economist Hyman Minsky sees the cycles of risk taking in the economy as following a pattern: stability and absence of crises encourage risk taking, complacency, and lowered awareness of the possibility of problems. Then a crises occurs, resulting in people being shell-shocked and scared of investing their resources. Strangely, both Minsky and his school, dubbed Post-Keynesian, and his opponents, the libertarian "Austrian" economists, have the same analysis, except that the first group recommends governmental intervention to smooth out the cycle, while the second believes that civil servants should not be trusted to deal with such matters." P:78
System 1: The experiential one, is effortless, automatic, fast, opaque (we do not know we are using it), parallel-processed. It is what we call "intuition".
System 2: The cognitive one, is what we call thinking. It is what you use in a calssroom, as it is effortful, reasoned, slow, logical, serial, progressive, and self-aware (you can follow the steps of your reasoning).
"Emotions are assumed to be the weapon System 1 uses to direct us and force us to act quickly." P:82
"Much of the trouble with human nature resides in our inability to use much of System 2, or to use it in a prolonged way without having to take a long beach vacation. In addition, we often just forget to use it." P:82
"Assume that ... your activities depend on a Black Swan surprise... Intellectual, scientific, and artistic activities belong to the province of Extremistan, where there is a severe concentration of success, with a very small number of winner claiming a large share of the pot...
Acknowledging the role of this concentration of success, and acting accordingly, causes us to be punished twice: we live in a society where the reward mechanism is based on the illusion of the regular; our hormonal reward system also needs tangible and steady results. It too thinks that the world is steady and well behaved - it falls for the confirmation error. The world has changed too fast for our genetic makeup. We are alienated from out environment." P:85
"Many people labor in life under the impression that they are doing something right, yet they may not show solid results for a long time. They need a capacity for continuously adjourned gratification to survive a steady diet of peer cruelty without becoming demoralized. They look like idiots to their cousins, they look like idiots to their peers, they need courage to continue. No confirmation comes to them, no validation, no fawning students, no Nobel, no Shnobel. "How was your year?" brings them a small but containable spasm of pain deep inside, since almost all of their years will seem wasted to someone looking at their life from the outside. Then bang, the lumpy event comes that brings the grand vindication. Or it may never come." P:87
"Making $1 million in one year, but nothing in the preceding nine, does not bring the same pleasure as having the total evenly distributed over same period, that is, $100000 every year for ten years in a row. The same applies to the inverse order - making bundle the first year, then nothing for the remaining period. Somehow, your pleasure system will be saturated rather quickly, and it will not carry forward the hedonic balance like a sum on a tax return. As a matter of fact, your happiness depends far more on the number of instances of positive feelings, what psychologists call "positive affect," than on their intensity when they hit. In other words, good news is good news first; how good matters rather little. So to have a pleasant life you should spread these small "affects" across time as evenly as possible." P:91
"Let us separate the world into two categories. Some people are like the turkey, exposed to a major blowup without being aware of it, while others play reverse turkey, prepared for big events that might surprise others. In some strategies and life situations, you gamble dollars to win a succession of pennies while appearing to be winning all the time. In others, you risk a succession of pennies to win dollars. In other words, you bet either that the Black Swan will happen or that it will never happen, two strategies that require completely different mind-sets." P:96
"Humans will believe anything you say provided you do not exhibit the smallest shadow of diffidence; like animals, they can detect the smallest crack in your confidence before you express it." P:98
"Numerous studies of millionaires aimed at figuring out the skills required for hotshotness follow the following methodology. They take a population of hotshots, those with big titles and big jobs, and study their attributes. They look at what those big guns have in common: courage, risk taking, optimism, and so on, and infer that these traits, most notably risk taking, help you to become successful. You should also probably get the same impression if you read CEO's ghostwritten autobiographies or attended their presentations to fawning MBA students.
Now take a look at the cemetery. It is quite difficult to do so because people who fail do not seem to write memoirs, and, if they did, those business publishers I know would not even consider giving them the courtesy of a returned phone call. Readers will not pay $26.95 for a story of failure, even if you convince them that it had more useful tricks than a story of success. The entire notion of biography is grounded in the arbitrary ascription of a casual relation between specified traits and subsequent events. Now consider the cemetery, The graveyard of failed persons will be full of people who shared the following traits: courage, risk taking, optimism, et cetera. Just like the population of millionaires. There may be some differences in skills, but what truly separates the two is for the most part a single factor: luck, Plain luck." P:105
"A life saved is a statistic; a person hurt is an anecdote. Statistics are invisible; anecdotes are salient. Likewise, the risk of a Black Swan is invisible.*
*Silence evidence can actually bias matters to look less stable and riskier than they actually are. Take cancer. We are in the habit of counting survival rates from diagnosed cancer cases - which would over estimate the danger from cancer. Many people develop cancer that remains undiagnosed, and go on to live a long and comfortable life, then die of something else, either because the cancer was not lethal or because it went into spontaneous remission. Not counting these cases biases the risks upward." P:112
"The reference point argument is as follows: do not compute odds from the vantage point of the winning gambler (or the lucky Casanova, or the endlessly bouncing back New York City, or the invincible Carthage), but from all those who started in the cohort. Consider once again the example of the gambler. If you look at the population of beginning gamblers taken as a whole, you can be close to certain that one of them (but you do not know in advance which one) will show stellar results just by luck. So, from the reference point of the beginning cohort, this is not a big deal. But from the reference point of the winner (and, who does not, and this is key, take the losers into account), a long string of wins will appear to be too extraordinary an occurrence to be explained by luck. Note that a "history" is just a series of nubers through time. The numbers can represent degrees of wealth, fitness, weight, anything." P:119
"Randomness and uncertainty are abstractions. We respect what happened, ignoring what could have happened. In other words, we are naturally shallow and superficial - and we do not know it. This is not psychological problem; it comes from the main property of information. The dark side of the moon is harder to see; beaming light on it costs energy. In the same way beaming light on the unseen is costly in both computational and mental effort." P:132
"I propose if you want a simple step to a higher form of life, as distant from the animal as you can get, then you may have to denarrate, that is, shut down the television set, minimize time spent reading newspapers, ignore the blogs. Train your reasoning abilities to control your decisions; nudge System 1 (the heuristic or experiential system) out of the important ones. This insulation from the toxicity of the world will have an additional benefit: it will improve your well-being. Also, bear in mind how shallow we are with probability, the mother of all abstract notions. You do not need to do much more to gain a deeper understanding of things around you. Above all, learn to avoid "tunneling.""
"Show two groups of people a blurry image of a fire hydrant, blurry enough for them not to recognize what it is. For one group, increase the resolution slowly, in ten steps. For the second, do it faster, in five steps. Stop at a point where both groups have been presented an identical image and ask each one of them to identify what they see. The members of the group that saw fewer intermediate steps are likely to recognize the hydrant much faster. Moral? The more information you give someone, the more hypothesis they will formulate along the way, and the worse off they will be. They see more random noise and mistake it for information." P:144
"The problem is that our ideas are sticky: Once we produce a theory, we are not likely to change our minds - so those who delay developing their theories are better off. When you develop you opinions on the basis of weak evidence, you will have difficulty interpreting subsequent information that contradicts these opinions, even if this new information is obviously more accurate. Two mechanisms are at play here: the confirmation bias ..., and belief perseverance. Remember that we treat ideas like possessions, and it will be hard for us to part with them." P:144
"The fire hydrant was first done in the sixties, and replicated several times sense. I have also studied this effect using the mathematics of information: the more detailed knowledge one gets of empirical reality, the more one will see the noise ( i.e. the anecdote) and mistake it for actual information. Remember that we are swayed by the sensational. Listening to the news on the radio every hour is far worse than reading a weekly magazine, because the longer interval allows information to be filtered a bit." P:144
"Finally in another telling experiment, the psychologist Paul Slovic asked bookmakers to select from eighty-eight variables in past horse races those that they found useful in computing the odds. These variables included all manner of statistical information about past performances. The bookmakers were given the ten most useful variables, then asked to predict the outcome of races. Then they were given ten more and asked to predict again. The increase in the information set did not lead to an increase in their accuracy; their confidence in their choices, on the other hand, went up markedly. Information proved to be toxic." P:145
"On one hand, we are shown by a class of expert-busting researchers such as Paul Meehl and Robyn Dawes that the "expert " is the closest thing to a fraud, performing no better than a computer using a single metric, their intuition getting in the way and blinding them. (As an example of a computer using a single metric, the ratio of liquid assets to debt fares better than the majority of credit analysts.)" P:146
"We can already see the difference between "know how" and "know-what". The Greeks made a distinction between techne and episteme." P:146
"In a study comparing them [security analysts] with weather forecasters, Tadeusz Tyszka and Piotr Zielonka documents that the analysts are worse predicting, while having a greater faith in their own skills. Somehow, the analysts' self-evaluation did not decrease their error margin after their failure to forecast." P:150
"I will go now into more general defects uncovered by this example. These "experts" were lopsided: on the occasions when they were right, they attributed it to their own depth of understanding and expertise; when wrong, it was either the situation that was to blame, since it was unusual, or, worse, they did not recognize that they were wrong and spun stories around it. They found it difficult to accept that their grasp was a little short. But this attribute is universal to all our activities: there is something in us designed to protect our self-esteem.
We humans are the victims of an asymmetry in the perception of random events. We attribute our successes to our skills, and our failures to external events outside our control, namely to randomness. We feel responsible for the good stuff, but not for the bad." P:152
"Hedgehogs, because of the narrative fallacy, are easier for us to understand - their ideas work in sound bites. Their category is over represented among famous people; ergo famous people are on average worse at forecasting than the rest of the predictors." P:153
"Similarly, ask someone to provide you with the last 4 digits of his social security number. Then ask him to estimate the number of dentists in Manhattan. You will find that by making him aware of the four-digit number, you elicit an estimate that is correlated with it.
We use reference points in our heads, say sales projections, and start building beliefs around them because less mental effort is needed to compare an idea to a reference point than to evaluate it in the absolute (system 1 at work!). We cannot work without a point of reference.
So the introduction of a reference point in a forecaster's mind will work wonders. This is no different from starting point in a bargaining episode. This is no different from a starting point in a bargaining episode: you open with high number ("I want a million for this house"); the bidder will answer "only eight-fifty" - the discussion will be determined by that initial level." P: 158
"Like many biological variables, life expectancy is from Mediocristan, that is, it is subject to mild randomness. It is not scalable, since the older we get, the less likely we are to live. In a developed country a newborn female is expected to die at around 79, according to insurance tables. When she reaches her 79th birthday, her life expectancy, assuming that she is in typical health, is another 10 years. At the age 90, she should have another 4.7 years to go. At the age of 100, 2.5 years. At the age of 119, if she miraculously lives that long, she should have about nine months left. As she lives beyond the expected date of death, the number of additional years to go decreases. This illustrates the major property of random variables related to the bell curve. The conditional expectation of additional life drops as a person gets older.
With human projects and ventures we have another story. These are often scalable, as I said in Chapter 3. With scalable variables, the ones from Extremistan, you will witness the exact opposite effect. Let's say a project us expected to terminate in 79 days, the same expectation in days as the newborn female has in years. On the 79th day, if the project is not finished, it will be expected to take another 25 days to complete. But on the 90th day, if the project is still not completed, it should have about 58 days to go. On the 100th, it should have 89 days to go. On the 119th, it will be expected to need an extra 1590 days. As you see, the longer you wait, the longer you will be expected to wait." P:159
" P:159
"The classical model of discovery is as follows: you search for what you know (say, a new way to reach India) and find something you didn't know was there (America).
If you think that the inventions we see around us came from someone sitting in a cubicle and concocting them according to a timetable, think again: almost everything of the moment is the product of serendipity. The term serendipity was coined in a letter by the writer Hugh Walpole, who derived it from a fairy tale, "The Three Princes of Serendip." These princes "were always making discoveries by accident or sagacity, of thins which they were not in quest of." P:166
"This multiplicative difficulty leading to the need for greater and greater precision in assumptions can be illustrated with the following simple exercise concerning the prediction of the movement of billiard balls on a table.I use the example as computed by the mathematician Michael Berry. If you know a set of basic parameters concerning the ball at rest, can compute the resistance of the table (quite elementary), and can gauge the strength of the impact, then it is rather easy to predict what would happen at the first hit. The second impact becomes more complicated, but possible; you need to be more careful about your knowledge of the initial states, and more precision is called for. The problem is that to correctly compute the ninth impact, you need to take into account the gravitational pull of someone standing next to the table (modestly, Berry's computations use a weight of less than 150 pounds). And to compute the fifty-sixth impact, every single elementary particle of the universe needs to be present in your assumptions! An electron at the edge of the universe, separated from us by 10 billion light-years, must figure in the calculations, since it exerts a meaningful effect on the outcome. Now, consider the additional burden of having to incorporate predictions about where these variables will be in the future. Forecasting the motion of a billiard ball on a pool table requires knowledge of the dynamics of the entire universe, down to every single atom! We can easily predict the movements of large objects like planets (though not too far into the future), but the smaller entities can be difficult to figure out - and these are so many more of them." P:178
"Corporations survive not because they have made good forecasts, but because, like the CEO visiting Wharton I mentioned earlier, they may have been the lucky ones. And, like a restaurant owner, they may be hurting themselves, not us - perhaps helping us subsidizing our consumption by giving us gods in the process, like cheap telephone calls to the rest of the world funded by the overinvestment during the dotcom era. We consmers can let them forecast all they want if that's what is necessary for them to get into business. Let them go hang themselves if they wish." P:180
"As individuals we should love free markets because operators in them can be as incompetent as they wish" P:181
"It has been more profitable for us to bind together in the wrong direction than to be alone in the right one." P:192
"The Black Swan asymmetry allows you to be confident about what is wrong, not about what you believe is right." P:192
"Psychologists have studied this kind of misprediction with respect to both pleasant and unpleasant events. We overestimate the effects of both kinds of future events on our lives." P:195
"The lesson for the small is: be human! Accept that being human involves some amount of epistemic ignorance in running your affairs. Do not be ashamed of that. Do not try to always withhold judgement - opinions are the stuff of life. Do not try to avoid predicting - yes, after this diatribe about prediction I am not arguing you to stop being a fool. Just be a fool in the right places.
What you should avoid is unnecessary dependence on large-scale harmful predictions - those and only those. Avoid the big subjects that might hurt your future: be fooled in small matters, not in the large. Do not listen to economic forecasters or to predictors in social science (they are mere entertainers), but do make your own forecast for the picnic.By all means, demand certainty for the next picnic; but avoid government social security forecasts for the year 2040.
Know how to rank beliefs not according to their plausibility but by the harm they might cause." P:203
"Indeed, we have psychological and intellectual difficulties with trial and error, and with accepting that series of small failures are necessary in life. My colleague Mark Spitznagel understood that we humans have a mental hang-up about failures: "You ned to love to lose" was his motto. In fact, the reason I felt immediately at home in America is precisely because American culture encourages the process of failure, unlike the cultures of Europe and Asia where failure is met with stigma and embarrassment. America's speciality is to take these small risks for the rest of the world, which explains this country's disproportionate share in innovations. Once established, an idea or a product is later "perfected" over there." P:204
"People are often ashamed of losses, so they engage in strategies that produce very little volatility but contain the risk of a large loss - like collecting nickels in front of steamroller. In Japanese culture, which is ill-adapted to randomness and badly equipped to understand that bad performance can come from bad luck, losses can severely tarnish someone's reputation. People hate volatility, thus engage in strategies exposed to blowups, leading to occasional suicides after big losses." P:204
"I am trying here to generalize to real life the notion of the "barbell" strategy I used as a trader, which is as follows. If you know that you are vulnerable to prediction errors, and if you accept that most "risk measures" are flawed, because of the Black Swan, then your strategy is to be as hyperconservative and hyperagressive as you can be instead of being mildly aggressive or conservative. Instead of putting your money in "medium risk" investments (how do you know is it medium risk? by listening to tenure-seeking "experts"?), you need to put portion, say 85 or 90 percent, in extremely safe instruments, like Treasury bills - as safe a class of instruments as you can manage to find in this planet. The remaining 10 to 15 percent you can put in extremely speculative bets, as leveraged as possible (like options), preferably venture capital-style protfolios. That way you do not depend on errors of risk management; no Black Swan can hurt you at all, beyond your "floor", the nest egg that you have in maximally safe investments. Or, equivalently, you can have a speculative protfolio and insure it if possible against losses of more than, say, 15 percent. You are "clipping" your incomputable risk, the one that is harmful to you. Instead of having medium risk, you have high risk on one side and no risk on the other. The average will be medium risk but constitute a positive exposure to the Black Swan. More technically, this can be called a "convex" combination." P:206
"Middlebrow thinkers sometimes make the analogy of such strategy with that of collecting "lottery tickets." It is plain wrong. First, lottery tickets do not have a scalable payoff; there is a known upper limit to what they can deliver. The ludic fallacy applies here - the scalability of real-life payoffs compared to lottery ones makes the payoff unlimited or of unknown limit. Secondly, the lottery tickets have known rules and laboratory-style well-presented possibilities; here we do not know the rules and can benefit from this additional uncertainty, since it cannot hurt you and can only benefit you." P:208
"Seize any opportunity, or anything that looks like opportunity. They are rare, much rarer than you think. Remember that positive Black Swans have a necessary first step: you need to be exposed to them. Many people do not realize they are getting a lucky break in life when they get it. If a big publisher (or a big art dealer or a movie executive or a hotshot banker or a big thinker) suggests and appointment, cancel anything you have planned: you may never see such a window open up again. I am sometimes shocked at how little people realize that these opportunities fo not grow on trees. Collect as many free non-lottery tickets (those with open-ended payoffs) as you can, and, once hey start paying off, do not discard them. Work hard, not in grunt work, but in chasing such opportunities and maximizing exposure to them. This makes living in big cities invaluable because you increase the odds of serendipitous encounters - you gain exposure to the envelop of serendipity. The idea of settling in a rural area on grounds that one has good communications "in the age of the Internet" tunnels out of such sources of positive uncertainty. Diplomats understand that very well: casual chance discussions at cocktail parties usually lead to big breakthroughs - not dry correspondence of telephone conversations. Go to parties! If you're a scientist, you will chance upon a remark that might spark new research. And if you are autistic, send your associates to these events" P:208
"Indeed, the notion of asymmetric outcome is the central idea of this book: I will never get to know the unknown since, by definition, it is unknown. However, I can always guess how it might affect me, and I should base my decisions around that." P:210
"I don't know the odds of an earthquake, but I can imagine how San Francisco might be affected by one. This idea that in order to make a decision you need to focus on the consequences (which you can know) rather than the probability (which you can't know) is the central idea of uncertainty." P:211
"But the role of luck is missing in Rosen's beautiful argument. The problem here is the notion of "better," this focus on skills are leading to success. Random outcomes, or an arbitrary situation, can also explain success, and provide the initial push that leads to a winner-take-all result. A person can get slightly ahead for entirely random reasons, because we like to imitate one another, we will flock to him. The world of contagion is so underestimated!" P:216
"More than a decade before Rosen, the sociologist of science Robert K. Merton presented his idea of the Matthew effect, by which people take from the poor to give to the Rich. He looked at the performance of scientists and showed how an initial advantage follows someone through life." P:216
"Note that art, because of its dependence on word of mouth, is extremely prone to these cumulative-advantage effects." P:218
"In sum, the long tail is a by-product of Extremistan that makes it some what less unfair: the world is made no less unfair for the little guy, but it now becomes extremely unfair for the big man. Nobody is truly established. The little guy is very subversive." P:225
"There is, inevitably, a mounting tension between our society, full of concentration, and our classical idea of aurea mediocritas, the golden mean, so it is conceivable that efforts may be made to reverse such concentration. We live in a society of one person, one vote, where progressive taxes have been enacted precisely to weaken the winners. Indeed, the rules of society can be easily rewritten by those at the bottom of the pyramid to prevent concentration from hurting them. But it does not require voting to do so - religion could often soften the problem. Consider that before Christianity, in many societies the powerful had many wives, thus preventing those at the bottom from accessing wombs, a condition that is not too different from the reproductive exclusivity of alpha males in many species. But Christianity reversed this, thanks to the one man-one woman rule. Later, Islam came to limit the number of wives to four. Judaism, which had been polygenic, became monogamous in the Middle Ages. One can say that such a strategy has been successful - the situation of tightly monogamous marriage (with no official concubine, as in the Greco-Roman days), even when practiced the "French way," provides social stability since there is no pool of angry, sexually deprived men at the bottom fomenting a revolution just so they can have the chance to mate." P:227
"What is poorly understood, or denied (owing to its unsettling implications), is the absence of a role for the average in intellectual production. The disproportionate share of the very few in intellectual influence is often more unsettling than the unequal distribution of wealth - unsettling because, unlike the income gap, no social policy can eliminate it. Communism can conceal or compress income discrepancies, but it could not eliminate the superstar system in intellectual life" P:227
"I'll summarize here and repeat the arguments previously made throughout the book. Measures of uncertainty that are based on the bell curve simply disregard the possibility, and the impact of sharp jumps or discontinuities and are, therefore, inapplicable in Extremistan. Using them is like focusing on the grass and missing out on the (gigantic) trees. Although unpredictable large deviations are rare, they cannot be dismissed as outliers because, cumulatively, their impact is so dramatic." P:236
"We can make good use of the Gaussian approach in variables for which there is a rational reason for the largest not too be too far away from the average. If there is gravity pulling numbers down, or if there are physical limitations preventing very large observations, we end up in Mediocristan. If there are strong forces of equilibrium, then again you can use the Gaussian approach." P:236
"Casino operators understand this well, which is why they never (if they do things right) lose money. They simply do not let one gambler make a massive bet, instead preferring to have plenty of gamblers make a series of bets of limited size." P:238
"To see how meaningless correlation can be outside of Mediocristan, take a historical series involving two variables that are patently from Extremistan, such as the bond and the stock markets, or two securities prices, or two variables like, say, changes in book sales of children's books in the United States, and fertilizer production in China; or real-estate prices in New York City and returns of the Mongolian stock market. Measure correlation between the pairs of variables in different subperiods, say, for 1994, 1995, 1996, etc. The correlation measure will be likely to exhibit severe instability; it will depend on the period for which it was computed. Yet people talk about correlation as if it were something real, making it tangible, investing it with a physical property, reifying it. " P:239
"If you're dealing with qualitative inference, such as in psychology or medicine, looking for yes/no answers to which magnitudes don't apply, then you can assume you're in Mediocristan without serious problems. The impact of the improbable cannot be too large. You have cancer or you don't, you are pregnant or you are not, et cetera. Degrees of deadness or pregnancy are not relevant (unless you are dealing with epidemics). But if you are dealing with aggregates, where magnitudes do matter, such as income, yor wealth, return on a portfolio, or book sales, then you will have a problem and get the wrong distribution if you use the Gaussian, as it does not belong there. Only single number can disrupt all your averages; one single loss can eradicate a century of profits." P:244
"As the reader can see, the main point of the Gaussian bell curve is, as I have been saying, that most observations hover around the mediocre, the mean, while the odds of a deviation decline faster and faster (exponentially) as you move away from the mean. If you need to retain one single piece of information, just remember this dramatic speed of decrease in the odds as you move away from the average. Outliers are increasingly unlikely. You can safely ignore them." P:250
"First central assumption: the flips are independent of one another. The coin has no memory. The fact that you got heads or tails on the previous flip does not change the odds of your getting heads or tails on the next one. The fact that you got heads or tails on the previous flip does not change the odds of your getting heads or tails on the next one. You do not become a "better" coin flipper over time. If you introduce memory, or skills in flipping, the entire Gaussian business becomes shaky. P:250"
"One can almost always ferret out predecessors for any thought. You can always find someone who worked on a part of your argument and use his contributions as your backup." P:256
"In the end it is those who derive consequences and seize the importance of the ideas, seeing their real value, who win the day. They are the ones who can talk about the subject." P:256
"This regress does not occur if you assume beforehand that the distribution is Gaussian. It happens that, for some reason, the Gaussian yields its properties rather easily. Extremistan distributions do not do so. So selecting the Gaussian while invoking some general law appears to be convenient. The Gaussian is used as a default distribution for that very reason. As I keep repeating, assuming its application beforehand may work with small number of fields such as crime statistics, mortality rates, matters from Mediocristan. But not for historical data of unknown attributes and not for matters from Extremistan." P:269
"If the world of finance was Gaussian, an episode such as the crash (more than 20 standard deviations) would take place every several billion lifetimes of the universe. According to the circumstances of 1987, people accepted that rare events take place and are the main source of uncertainty. They were just unwilling to give up on the Gaussian as a central measurement tool - "Hey, we have nothing else." People want a number to anchor on. Yet the two methods are logically incompatible." P:276
"Merton wrote that before portfolio theory, finance was "a collection of anecdotes, rules of thumb, and manipulation of accounting data." Portfolio theory allowed "the subsequent evolution from this conceptual postpouri to a rigorous economic theory." P:278
"A theory is like medicine (or government): often useless, sometimes necessary, always self serving, and on occasion lethal. So it need to be used with care, moderation, and close adult supervision." P:285
"The ludic fallacy is present in the following chance setups: random walk, dice throwing, coin flipping, the infamous digital "heads or tails" expressed as 0 or 1, Brownian motion, and similar examples. These setups generate a quality of randomness that does not even qualify as randomness - protorandomness would be more appropriate designation. At their core, all theories built around the ludic fallacy ignore a layer of uncertainty. Worse, their proponents do not know it!" P:287
"People who worry about pennies instead of dollars can be dangerous to society. They mean well, but, invoking my Bastiat argument of Chapter 8, they are a threat to us. They are wasting our studies of uncertainty by focusing on the insignificant. Our resources (both cognitive and scientific) are limited, perhaps too limited. Those who distract us increase the risk of Black Swans." P:288
"(I also have to confess that I do not worry a lot, I try to worry about matters I can do something about). I worry less about embarrassment than about missing an opportunity." P:296
"Missing the train is only painful if you run after it! Likewise, not matching the idea of success others expect from you is only painful if that's what you are seeking." P:297
"The corollary is obvious: since there is nothing new about the crises of 2008, we will not learn from it and we will make the same mistake in the future. And the evidence is there at the time of writing: the IMF continues to issue forecasts (not realizing tjat previous ones did not work and that the poor suckers relying on them are - once again - going to get in trouble." P:322
"..So where is he getting this "once in ten thousand years" probability? Certainly not from personal experience; certainly not from the records of Lehman Brothers - his firm had not been around for 10000 years, and of course it didn't stay around for another 10000 years, as it went under right after our debate. The more remote the event, the less we can get empirical data (assuming generously that the future will resemble the past) and the more we need to rely on theory.
Consider that the frequency of the rare events cannot be estimated from empirical observation for the very reason that they are rare. We thus need a prior model representation for that; the rarer the event, the higher the error in estimation from standard inductive methods (say, frequency sampling from counting past occurrences), hence the higher the dependence on a priori representation that extrapolates into the space of low probability events (which necessarily are not seen often).
But even outside of small probabilities, the a priori problem is always present. It seems salient with respect to rare events, but it pervades probabilistic knowledge. I will present two versions I have been working on with two collaborators, Avital Piple, a philosopher of science (he walks fast), and Raphael Douady, a mathematician (he is sometimes a good walker, when he is not busy).
Epimenides the Cretan
Avital Pilpel and I expressed the regress argument as follows, as the epistemic problem of risk management, but the argument can be generalized to any form of probabilistic knowledge. It is a problem of self-reference by probability measures.
We can state it in the following way. If we need data to obtain a probability distribution to gauge knowledge about the future behavior of the distribution from its past results, and if, at the same time, we need a probability distribution to gauge data sufficiency and whether or not it is predictive of the future, then we face a severe regress loop.This is a problem of self-reference akin to that of Epimenides the Cretan stating whether of not Cretans are liars. Indeed, it is too uncomfortably close to the Epimenides situation, since a probability distribution is used to assess the degree of truth but cannot reflect on its own degree of truth and validity. And, unlike many problems of self-references, those related to risk assessment have severe consequences. The problem is more acute with small probabilities.
An Undecidability Theorem
This problem of self-reference, published with Pilpel after the Black Swan, went unnoticed as such. So Raphael Douady and I re-expressed the philosophical problem mathematically, and it appears vastly more devastating in it's practical implications than the Godel problem.
Raphael is, among the people I know, perhaps the man with the greatest mathematical erudition - he may have more mathematical culture than anyone in modern times, except perhaps for his late father, Adrien Douady.
At the time of writing, we may have produced a formal proof using mathematics, and a branch of mathematics called "measure theory" that was used by the French to put rigor behind the mathematics of probability. The paper is provisionally called "Undecidability: On the inconsistency of estimating probabilities form a sample without binding a priori assumptions on the class of acceptable probabilities."
It's the Consequences...
Further, we in real life do not care about simple, raw probability ( whether an event happens or does not happen); we worry about consequences (the size of the event; how much total destruction of lives or wealth, or other losses, will come from it; how much benefit a beneficial event will bring). Given that the less frequent the event, the more severe the consequences (just consider the the hundred-year floor is more severe, and less frequent, than the ten-year flood; the best seller of the decade ships more copies than the [best seller] of the year), our estimation of the contribution of the rare event is going to be massively faulty (contribution is probability times effet; multiply that by estimation error); and nothing can remedy it.
So the rarer the event, the less we know about its role - and the more we need to compensate for that deficiency with an extrapolative, generalizing theory. It will lack in rigor in proportion to claims about the rarity of the event. Hence theoretical and model error are more consequential in the tails; and, the good news, some representations are more fragile than others.
I showed that this error is more severe in Extremistan, where rare events are more consequential, because of a lack of scale, or a lack of asymptotic ceiling for the random variable. In Mediocristan, by comparison, the collective effect of regular events dominates and the exceptions are rather inconsequential - we know their effect, and it is very mild because one can diversify thanks to the "law of large numbers." Let me provide once again an illustration of Extremistan. Less than 0.25 percent of all the companies listed in the world represent around half the market capitalization, a less than minuscule percentage of novels on the planet accounts for approximately half fiction sales, less than 0.1 percent of drugs generate a little more than half the pharmaceutical industry's sales and less than 0.1 percent of risky events will cause at least half the damages and losses." P:352
"But the problem gets more interesting in some domains. Recall the Casanova problem in Ch8. For environments that tend to produce negative Black Swans, but not positive Black Swans (these environments are called negatively skewed), the problem of small probabilities is worse. Why? Clearly, catastrophic events will be necessarily absent from the data, since the survivorship of the variable itself will depend on such effect. Thus such distributions will let the observer become prone to overestimation of stability and underestimation of potential volatility and risk.
This point - that things have a bias to appear more stable and less risky in the past, leading us to surprises - needs to be taken seriously, particularly in the medical field. The history of epidemics, narrowly studied, does not suggest the risks of the great plague to come that will dominate the planet. Also I am convinced tat in doing what we are t the environment, we greatly underestimate the potential instability we will experience somewhere from the cumulative damage we have done to nature.
One illustration of this point is playing out just now. At the time of writing, the stock market has proved much, much riskier than innocent retirees were led to believe from historical discourses showing a hundred years of data. It is down to close to 23 percent for the decade ending in 2010, while the retiress were told by finance charlatans that is was expected to rise by around 75 percent of that time span. This has bankrupted many pension plans ( and the largest car company in the world), for they truly bought into that "empirical" story - and of course it has caused many disappointed people to delay their retirement. Consider that we are suckers and will gravitate toward those variables that are unstable but that appear stable.
Preasymptotics. Let us return to Platonicity with a discussion of presymptotics, what happens in the short term. Theories are of, of course, a bad thing to start with, but they can be worse in some situations when they were derived in idealized situations, the asymptote, but are used outside the asymptote (its limit, say infinity or the infinitesimal). Mandelbrot and I showed how some asymptotic properties do work well preasymptotically in Mediocristan, which is why casinos do well; matters are different in Extremistan.
Most statistical education is based on these asymptotic, Platonic properties, yet we live in the real world, which rarely resembles the asymptote. Statistical theorists know it, or claim to know it, but not your regular user of statistics who talks about "evidence" while writing papers. Furthermore, this compounds what I called the ludic fallacy: most of what students of mathematical statistics do is assume a structure similar to the closed structures of games, typically with a priori known probability. Yet the problem we have is not so much making computations once you know the probabilities, but finding the true distribution for the horizon concerned. Many of our knowledge problems come from this tension between a priori and a posteriori.
Proof in the flesh
There is no reliable way to compute small probabilities. I argued philosophically the difficulty of computing the odds of rare events. Using almost all available economic data - and I used economic data because that's where the clean data was - I showed the impossibility of computing from the data the measure of how far away from the Gaussian one was. There is a measure called kurtosis that the reader does not need to bother with, but that represents "How fat the tails are," that is, ow much rare events play a role. Well, often, with then thousand pieces of data, forty years of daily observations, one single observation represents 90 percent of the kurtosis! Sampling error is too large for any statistical inference about how non-Gaussian something is, meaning that if you miss a single number, you miss the whole thing. The instability of the kurtosis implies that a certain class of statistical measures should be totally disallowed. This proves that everything relying on "standard deviation," "variance," "least square deviation," etc. is bogus.
Further, I also showed that it is impossible to use fractals to get acceptably precise probabilities - simply because a very small change in what I called the "tail exponent" in Ch 16, coming from observation error, would make the probabilities change by a factor of 10, perhaps more.
Implication: the need to avoid exposure to small probabilities in a certain domain. We simply cannot compute them. " P:355
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"Our research shows that the way a risk is framed sharply influences people's understanding of it. If you say that, on average, investors will lose all their money every thirty years, they are more likely to invest than if you tell them they have a 3.3 percent change of losing certain amount every year." P:358
"[if you ask people] Safety statistics show that, if you fly once a year, there will be on average one crash every thousand years on this airline. All the respondents said they would [fly]. But when we changed the second so it read, "Safety statistics show that, on average, one in a thousand flight on this airline have crashed," only 70 percent said they would take the flight. In both cases, the chance of a crash is 1 in 1000; the latter formulation simply sounds more risky." P:358
"I tried to explain the problems of errors in monetary policy under non-linearities: you keep adding money with no result...until there is a hyperinflation. Or nothing. Governments should not be given toys they do not understand." P:360
"How do you live long? By avoiding death. Yet people do no realize that success consists mainly in avoiding losses, not in trying to derive profits." P:368
"Linked to this need for positive device is the preference we have to do something rather than nothing, even in cases when doing something is harmful." P:368
"The nihilism label has always been used to harm. Practitioners who were conservative and considered the possibility of letting nature do its job, or who stated the limits of our medical understanding, were until the 1960s accused of "theraputic nihilism". It was deemed "unscientific" to avoid embarking on a course of action based on an incomplete understanding of the human body - to say, "This is the limit; this is where my body of knowledge stops." It has been used against this author by intellectual fraudsters trying to sell products." P:369
"You could satisfy your illusion of control by going to the Temple of Apollo rather than seeing the doctor. What is interesting is that the ancient Mediterraneans may have understood the trade-off very well and my have accepted religion partly as a tool to tame the illusion of control.
You cannot do anything without knowledge unless you know where it stops, and the costs of using it. Post-Enlightenment science, and its daughter superstar science, were lucky to have done well in (linear) physics, chemistry, and engineering. But at some point we need to give up on elegance to focus on something that was given short shrift for a very long time: the maps showing what current knowledge and current methods do not do for us; and a rigorous study of generalized scientific iatrogenics, what harm can be caused by science (or, better, and exposition of what harm has been done by science). I find it the most respectable of pursuits." P:370
"The most obvious was to exit the Fourth Quadrant is by "truncating", cutting certain exposures by purchasing insurance, when available, putting oneself in the "barbell" situation..." P:370
"On the other hand, research ventures show a less rosy past history. A biotech company (usually) faces positive uncertainty, while a bank faces almost exclusively negative shocks." P:373
"2. No socialization of losses and privatization of gains.
Whatever may need to be bailed out should be nationalized; whatever does not need to be bailed out should be free, small, and risk-bearing. We got ourselves into the worst of capitalization and socialism. In France, in the 1980s, the socialists took over the banks. In the United States in the 2000s, the bans took over the government. This is surreal." P: 374
"4. Don't let someone making an "incentive" bonus manage a nuclear plant - or your financial risks.
Odd are he would cut every corner on safety to show "profits" from these savings while claiming to be "conservative". Bonuses don't accommodate the hidden risks of blowups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards." P:375
"Seneca is the one who taught Montaigne that to philosophize is to learn how to die. Seneca is the one who taught Nietzsche the armor fati, "love fate", which prompted Nietzsche to just shrug and ignore adversity, mistreatment by his critics, and his disease, to the point of being bored by them." P:378
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