19 Apr 2009

The Black Swan -- The Review

I just finished reading Nassim Taleb's second great book, and I highly recommend it.

His point -- oversimplified -- is that we do not understand the frequency of rare, high-impact events (black swans) because they do not fit into our perception. (We usually tell stories to explain things ex-post and we often extrapolate from the past.) That may not be a problem EXCEPT that financial "wizards" have made the fatal mistake of "normalizing" the distribution of events to look like a Bell Curve (or Gaussian distribution). What this means in practice is that they boldly predict that "so-and-so is likely to happen once in 100 years," and are then proven wrong over and over. (Reminds me of the hundred year flood fallacy...)

He also takes some time to tear apart economic models, assumptions of perfect rationality, use of the expected utility function, etc. I agree whole-heartedly with this critique and the implication that academic economists are not only useless but dangerous advisers on real-world problems. He holds up Hayek's ideas on the "knowledge problem" (our inability to know everything in one place at one time means that we cannot make "right" decisions from a central point. The alternative -- disaggregated decision-making via markets and prices -- is much more efficient and less likely to produce catastrophic failures like those we've seen in the financial markets.)

Finally, Taleb predicted (accurately) the self-destruction of the financial markets that has been driven by unrealistic beliefs on the occurrence of "rare but dangerous" events...

Bottom Line: If you only read five books on markets and economics, make this one of them (I'll put up a reading list if I get this teaching thing cleared up...). FIVE STARS.


Eric said...


Why isn't the brain green? In today's NYT.

Mark S said...

For a book treating the same proposition ("we do not understand the frequency of rare, destructive events... because they do not fit into our perception") in terms of California water, I recommend Jared Orsi's "Hazardous Metropolis"(2004).

J. Cress said...

" that academic economists are not only useless but dangerous advisers on real-world problems "

Claims like these ignore black swans. In fact, its largely from within economics that the assumptions and models used by economists are criticized and improved.

Humbly, there is no consensus among economists on real-world problems, hence arguing that 'economists are bad at real world problems' depends upon which economist you ask.
In my view, most economic policy failures come from ignoring economics, not embracing it.

I agree that Taleb's book is a must read, and I don't disagree with much of what he says about economics, its the generalization of those statements I take issue with. His criticisms seem to apply to macroeconomics much more than micro, and bad macroeconomics more than good macroeconomics.

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