Recently I was reading a news column the best predictive model for the US presidential election projects Donald Trump winning the election in November with a caveat the creator of the model himself did not trust the prediction of his model as he believed all the assumptions the model uses don’t fit in this election year as this year election is a Black Swan Election. Now what does that really mean? The possibility of Donald Trump being the Presidential Election was improbable to begin with which in the end became a possibility but still is improbable in any given scenario. The highly unlikely event of Donald Trump being elected as a Republican Nominee is for all practical reasons is being described as a black swan event by the creator of the so called model which had the best track record of predicting the presidential election winner from 1992.
Black Swans? They do exist. The black swan (Cygnus atratus) is a large waterbird, a species of swan, which breeds mainly in the southeast and southwest regions of Australia. Now how does that matter if black swans exist or not. It does matter because before the discovery of Black swans in Australia the existence of a Black swan was seen as a highly improbable event. The phrase “black swan” derives from a Latin expression; its oldest known occurrence is the poet Juvenal’s characterization of something being “rara avis in terris nigroque simillima cygno” (“a rare bird in the lands and very much like a black swan”). When the phrase was coined, the black swan was presumed not to exist. So that was in short how the phrase Black Swan Event was coined to describe an event that comes as a surprise, has a major effect, and is often inappropriately rationalized after the fact with the benefit of hindsight.
Now where do we go from here and how do the white swans grey swans and turkeys fit in. To add more context the black swan theory was made famous by Nassim Taleb in his book titled Black Swan which not going into the technicalities is about the inability of correctly forecasting improbable events in financial markets using past predictors to say the least. So to Tee off in a more technical language understood by Risk Managers the Black Swan event is like a Tail Event with very low probability. Now what is a Tail Event? Well Here I am afraid you have to go the basics to understand the normal distribution curve. Well In short Black Swan is a highly unlikely event. Interestingly Nassim uses turkeys to explain the Black Swan Effect.
Taleb’s fables regarding Black Swan type events is that of the turkeys that are raised for Christmas dinner — although think of any other suitable farm animal, or even users of popular websites. Judging from past events, the turkey can consider itself lucky. It is fed and watered every day and generally kept happy. No indication from these past events suggests that one day it might be slaughtered for food. However, after this event (assuming the turkey lives at least to the point where it finally figures it out) it becomes “obvious” that it was being raised for slaughter; the protection and vaccinations are to keep it healthy, the excess food is to fatten it up. In short, after the event, the narrative becomes clear.
Until that point, however, the turkey would have no idea and it would be unfair to say that the turkey would have been able to predict its own demise from its 100 day eating binge during that time itself. But even more important to how psychology prevents us from recognizing “the black swan problem” is that the turkey’s belief that every day would be fantastic would be reinforced by the fact that every day was fantastic. The accumulation of supporting information doesn’t just reassure the turkey, but also actively destroys its ability to think about what it doesn’t know. As a result the turkey undergoes a terminal revision of belief on the very day it has received the maximum validation of the belief that its life will continue getting better.
The moral of the story; do not be a turkey. Alternatively don’t trust burgeoning stock markets or constantly rising house prices.
Well I would now extend it further to our personal lives. We all have good times and bad times What the Black Swan theory is suggesting a continuous purple patch is no guarantee of good times for ever and there is a Black Swan lurking down the corner. But are we all prepared to handle Black Swan Events I say who cares any way why should we be prepared for an event so highly unlikely however we need to be prepared for Grey Swan Events which In the more generic sense refer to events like earth quakes and Hurricanes in general but I would like to scale them further down in a personal situation like getting involved in a car accident or losing a job which implies in short stash the cash for a rainy day but what’s the point in stashing all the cash away anticipating a Black Swan? My Moral of the Story Ignore the Black Swan but at least be prepared for a Grey Swan and live life like a graceful white swan.