The Hindu Business Line : Investment Nuggets

"My major hobby is teasing people who take themselves and the quality of their knowledge too seriously and those who don't have the guts to sometimes say: I don't know..." (You may not be able to change the world but can at least get some entertainment and make a living out of the epistemic arrogance of the human race). So declares the Web site of Nassim Nicholas Taleb, a mathematical trader and literary essayist, whose contrarian streak is evident in these words.

Famous for his two books, Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets, first published in 2001, and his latest book The Black Swan: The Impact of the Highly Improbable, he has been obsessed with problems in probability and uncertainty for several years. Apart from being a distinguished member of the Derivatives Hall of Fame, he is also a founder of Empirica LLC, a firm that provides portfolio protection strategies for hedge funds.

"One can study randomness at three levels: Mathematical, empirical, and behavioural. The first is the narrowly defined mathematics of randomness, which is no longer the interesting problem because we've pretty much reached small returns in what we can develop in that branch. The second one is the dynamics of the real world, the dynamics of history, what we can and cannot model, how we can get into the guts of the mechanics of historical events, whether quantitative models can help us and how they can hurt us. And the third is our human ability to understand uncertainty.

"We are endowed with a native scorn of the abstract; we ignore what we do not see, even if our logic recommends otherwise. We tend to overestimate causal relationships. When we meet someone who by playing Russian roulette became extremely influential, wealthy, and powerful, we still act toward that person as if he gained that status just by skills, even when you know there's been a lot of luck. Why? Because our behaviour toward that person is going to be entirely determined by shallow heuristics and very superficial matters related to his appearance."

"A black swan is an outlier, an event that lies beyond the realm of normal expectations. Most people expect all swans to be white because that's what their experience tells them; a black swan is by definition a surprise. Nevertheless, people tend to concoct explanations for them after the fact, which makes them appear more predictable, and less random, than they are. Our minds are designed to retain, for efficient storage, past information that fits into a compressed narrative.

"This distortion, called the hindsight bias, prevents us from adequately learning from the past. Black swans can have extreme effects: just a few explain almost everything, from the success of some ideas and religions to events in our personal lives. Moreover, their influence seems to have grown in the 20th century, while ordinary events — the ones we study and discuss and learn about in history or from the news — are becoming increasingly inconsequential."

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