Black Swan Theory

Wikipedia describes Nassim Taleb’s Black Swan Theory as follows:

“1) the disproportionate role of high-impact, hard to predict, and rare events that are beyond the realm of normal expectations in history, science, finance and technology, 2) the non-computability of the probability of the consequential rare events using scientific methods (owing to their very nature of small probabilities) and 3) the psychological biases that make people individually and collectively blind to uncertainty and unaware of the massive role of the rare event in historical affairs.”

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So what does this mean? First, a Black Swan event is nearly impossible for most people to predict, but it has outsized importance because of its widespread impact. People tend to think that change happens at a slow, steady pace, incrementally in other words. Taleb argues that change actually happens quite quickly, has a huge impact in a short period of time, and was not foreseen by anyone, not even the so-called “experts.” This is why understanding Black Swan events is so important.

Second, before a Black Swan event happens, people think that the probability of such an event occurring is so small that it is virtually zero. People’s estimation of the probability of a Black Swan event occurring is so small that it is virtually impossible to estimate accurately. This is why Black Swan events are so hard to predict.

Third, people have built-in psychological limitations and biases that make them unable to predict Black Swan events before they occur. Similar biases lead people to claim that they foresaw a Black Swan event after it occurs, even though they didn’t foresee it all. In other words, the Black Swan event becomes predictable only after it occurs, which is certainly a contradiction.

Examples of positive Black Swan events include the invention of the personal computer and the internet. Examples of negative Black Swan events include September 11 and the financial crisis of 2007-2008. All of these events were not foreseen by most people, yet they had huge impacts across societies.

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