Russ Roberts interviews Nassim Taleb. It’s one of the most fascinating interviews in Roberts’ series.
One implication of Taleb’s thinking is that we are overconfident in our ability to manage risk. Burt Malkiel, who is arguing from a more traditional perspective, thinks that stock markets right now seem to be priced for very little risk.Some notes I jotted down during the interview (my own thoughts in parentheses):
confirmation bias–not taking seriously what you don’t see, taking too seriously what you see. So if you haven’t seen an event, you tend to rule it out
in our modern enviroment, we are more likely to encounter extremes
bankers assume that we don’t have fat tails. (think of sub-prime loans, where the bankers came to think that they had the risks under control. What they were doing was writing out-of-the-money options, which is fine as long as markets don’t move too much. In my view Enron’s collapse came from the same tactic–writing out-of-the-money options, in this case on their own stock.)
hindsight bias. we think we predicted the odd event, or we could have predicted it.
80 pct of epidemiological studies fail to replicate. Thus, when you read in the paper that “X is found to give you cancer” or help with weight loss, do not assume that the study is correct.
easy to predict that after ice cube melts, there will be water on the floor. harder to infer what happened if you observe water on the floor. (but with hindsight bias, we will claim that we knew all along that there was an ice cube)
so many people are in the market, you will have lots of spurious winners. Trying to become a winner on Wall Street is hard, because even if you are smart, you are competing with all the spurious winners.
in a world of statistical extremes, you don’t want to be in banking or reinsurance; you want to be in biotech. (In a world with fat tails, you don’t want to be writing options, as a banker or a reinsurer is doing. You want to be long options, like a venture capitalist.)
go to parties, because serendipity matters. (when I was an entrepreneur, whenever I got the sense that I was just spinning my wheels, I tried to meet new people in order to change my luck.)
people have a hard time seeing animals as randomly selected. but even those who do accept that, do not accept that a car is the product of a random process
we are not good at planning, we’re not good at knowing. we’re just good at doing
most of what people were looking for, they did not find; most that they found, they did not look for
(so with hindsight bias, you tend to make discoveries and inventions appear to be more planned and systematic than they really were)
penicillin was mold that Fleming came across.
national cancer institute discovered almost nothing. accidental discoveries were more important.
However, saying that success requires luck is not the same as saying that only luck determines success.
There is quite a bit more to the interview, including critiques of mainstream economics. I recommend listening to the whole thing.
I briefly posted on Taleb earlier here.
READER COMMENTS
Tim Lundeen
Apr 30 2007 at 11:48am
As it happens, I’m about 1/2 way through Taleb’s recent book, The Black Swan, and it is excellent. Lots and lots of great insight.
It is funny how this and the last two books I read all fit together: The Strategy Paradox by Raynor, and The Origin of Wealth by Beinhocker. (All three highly recommended.)
Beinhocker’s view is that a business is trying to survive and succeed in an evolutionary environment where the fitness function changes over time in response to events and to what other people do. In an evolutionary environment, you want to do some local hill-climbing to find a local maximum, but you also need to do some exploring of other areas to see if there are higher peaks somewhere else. A “Black Swan” in this model is some extraordinary event that dramatically changes the fitness landscape.
Raynor argues that a business strategy should be based on time horizons and coping with risk: higher levels in the management hierarchy should be looking at longer time horizons and longer-term risks; the bottom layers should be focused on near-term results.
If you translate Raynor’s strategy model into Beinhocker’s evolutionary model, what it means is that the bottom layers of management are hill-climbing, trying to optimize current business lines in a relatively slowly-changing environment. Higher management is looking at the direction of the business, how to mitigate risks from possible major changes in the environment, and how to find other peaks to start exploring.
Taleb has great insight into the ways in which an environment can change, the associated risks, and argues for the value of understanding as much as we can. I like his example of the Thanksgiving turkey: from the turkey’s perspective, it gets fed every day for 100s of days. By induction, the turkey figures out this is how the world works. Then Thanksgiving arrives, and everything changes overnight. The moral is that it is better to look at the world with more understanding of how it works, to try to avoid being the turkey.
I think Taleb discounts the value of hill-climbing too much; there is a lot to be gained and learned from this, as long as you don’t lose sight of the fact that your hill may disappear very quickly as the environment changes.
I’m the CEO of a small entrepreneurial company, and I started learning economics because I wanted to understand what happened in 2000-2001. In some real sense, I was the turkey — we had been growing at 50% per year for years, and we just needed another year or two of similar growth to be in great shape. Then, overnight, the environment changed and businesses stopping investing, and we changed from growth to survival mode.
Hopefully I’ve learned something from my reading and trying to build better models of how the world works. But it is a fascinating journey, still underway, and quite enjoyable in its own right.
Fundamentalist
May 1 2007 at 9:22am
I read Taleb’s “Fooled by Randomness” and really enjoyed it. He said in that book that he has made most of his money investing in rare events, such as the 1987 market crash and the 2000 collapse. Rare events, he wrote, are always underpriced.
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