Swan Song
Print
Comment
Email
RSS
Twitter
Swan Song
First he was very famous, now he's very rich. But Nassim Taleb is still wrong.
By Mark Gimein
Posted Monday, June 15, 2009 - 2:16pm
While for just about everyone involved in the markets the last two years of financial history have been a massacre, they have been a long victory lap for Nassim Nicholas Taleb. Taleb is the author of The Black Swan, the book about, as the subtitle puts it, "The Impact of the Highly Improbable." It came out in 2007, just before everything that seemed highly improbable became painfully actual. As everyone else's fortunes have shrunk, Taleb's have risen. Not only have his books made him the public face of the New Catastrophism, but his insights have turned out to be extremely profitable: The Wall Street Journal reports that Universa, a hedge fund for which Taleb serves as guru and adviser, gained more than 100 percent last year and now holds $6 billion.
It's hard to argue with success. In bubble markets and bear markets, the talk always turns to new paradigms. If there was a huge crash yesterday, why shouldn't there be an even bigger one tomorrow? For a while now, though, I've been trying to explain to people why I am loath to jump on the Taleb bandwagon. The news about Universa doesn't change this. I am not surprised that Taleb's approach has made money for investors. But I will be if—assuming he doesn't change his approach—he keeps doing so.
Taleb has become the go-to philosopher of the markets with a straightforward and appealing precept: that people always underestimate the chances of improbable, out-of-the-ordinary events. This to me seems a dangerous proposition about the markets. It is also, I think, a questionable proposition about human behavior.
While Taleb has acquired a huge following in the world of business and investment, he does not present himself mainly as a "business" thinker. Little of his 2004 book, Fooled by Randomness, and even less of The Black Swan talks about investing directly. His conceit is that he helps readers see possibility. It is attractive because it separates people into the plodders—or, as Taleb calls them, nerds—and the street-smart Talebites who've learned to appreciate the unexpected. But the closer you look, the less clear it is that the plodders are as consistently wrong as Taleb thinks.
One thing to be said in Taleb's favor is that he has never lost a spectacular amount of money at once. Three times now he has made money when few others did. The first was in the 1987 Black Monday stock market crash, when he made $35 million to $40 million as a trader. The second was the tech stock crash of 2000, when Taleb's own fund, Empirica, gained 60 percent. And the third is Universa.
What you might miss in this, though, is what happened to Taleb in the in-between years. Taleb, in the pre-Universa days, said that his Black Monday windfall made up 97 percent of the money he'd made. Afterward, he moved through several trading jobs without much success. In 1999, he started Empirica, which, as the Wall Street Journal reported, followed the gains of 2000 with several lackluster years and closed in 2004. In Taleb's telling, this is part of the magic. "When you lose money steadily and then make money in lumps," Taleb told Bloomberg magazine, "people think you're crazy."
Photograph by Carsten Koall/Getty Images.
Comments
portfolio aspect
I think what is missing from this article and the analysis of this strategy is that it is not meant to be a stand alone wealth maximization strategy. Nassim would not tell you to invest all of your money in these entities. I think what he would tell you is that, these strategies can work extremely well as a hedge against the majority of hedge fund strategies that either explicitly or implicitly are selling the convexity that he is acquiring. That said, as volatilities are at historically high levels, perhaps it's better to enter the strategy in a lower vol environment. In essence, that is all he is doing..... he is going long volatility, particularly the wings.
Mark, you really missed the point
"As Taleb points out, we notice the ones who do well a lot more because those who do badly simply drop out of sight. So it is also with predictions of disaster: We mostly get to hear about the few times that they turn out to be right."
Dear Mark,
Reading your last sentence says it all about you totally missing the point on Taleb. If you had studied carefully Taleb's Fooled by Randomness you would have known that he DOES NOT make any predictions. He is totally against those making predictions. He laughs at them. To simply put it, he makes a skewed bet, a bet whose pay-off is positive: loses a little most of the time, but when it makes money it recovers the previos losses and remains with a profit. AND THAT IS BECAUSE US HUMANS DO NOT PRICE CORRECTLY THE CHANCES OF THE RARE EVENT OCCURING. IT IS OUR NATURE.
Mark, you really need to revisit your opinions and most of all, read carefully Talebs Fooled by Randomness. I am sure you will catch the point eventually. It's a real shame to make Taleb wrong when you do not understand what he says.
let me be blunt
did you read the black swan? on page 96 of the hardcover edition is subheading titled BLEED OR BLOWUP. in this part of the chapter, his fictional character nero goes on to explain his trading style:
"His premise was the following trivial point: some business bets in which one wins big but infrequently, yet loses small but frequently, are worth making if others are suckers for them and if you have the personal and intellectual stamina...a strategy he called 'bleed.' You lose steadily, daily, for a long time, except when some event takes place for which you get paid disproportionately well. No single event can make you blow up [that is lose more than you considered possible], on the other hand—some changes in the world can produce extraordinarily large profits that pay back such bleed for years, sometimes decades, sometimes even centuries." [emphasis his] p. 97
what, mr. gimein, is the title of the chapter? LIVING IN THE ANTECHAMBER OF HOPE, of course. and what could that possibly be about? it's probably not about the character drogo from THE TARTAR STEPPE, who becomes "inebriated" by the hope of being a hero in a battle against the tartars at the edge of the desert—a desert no one has crossed. drogo spends his entire life putting his return to society on hold:
"At the end of the novel we see Drogo dying in a roadside inn as the event for which he has waited all his life takes place. He has missed it." p. 93
and the next subheading THE SWEET TRAP OF ANTICIPATION:
"I presented the Black Swan as the outlier, the important event that is not expected to happen. But consider the opposite: the unexpected event that you very badly want to happen. Drogo is obsessed and blinded by the possibility of an unlikely even; that rare occurrence is his raison d'être." [emphasis his] p. 93
now to quote you:
"In his books Taleb presents a wealth of examples of how prone we are to discount the unexpected and unlikely, but what is notably missing from The Black Swan are examples of just how likely we are to overestimate the chances of unlikely events when they are presented to us under a spotlight. Taleb is, of course, right that we fail to anticipate what we are not looking for. But we also overanticipate when we are looking too hard for the outliers. Lottery players overvalue their chances of winning $10 million, and horse bettors put too much money on 100-1 long shots. People who watch the local news too avidly believe there is a child kidnapper around every corner, and followers of Taleb assume that every time they pass a dark alley, catastrophe is about to pop out with a bloody knife." [bold mine, of course]
now let me ask again: DID YOU READ THE BLACK SWAN?
what was that...is that pie on your face...bet you didn't expect that!
journalistic integrity rating: 0
Taleb's full of it
Reading The Black Swan made me so angry. Taleb's assault on the discipline of mathematics was self-aggrandizing and completely wrong. Statistics is always about chance, never about certainty. Statisticians look at samples and populations for different types of distributional patterns. There's statistical tests based on the Gaussian curve, but there are also rich subfields in methodologies to deal with populations with higher degrees heteroskedasticity (structure in the error term). These subfields are uniquely suited for modeling populations and events that tend to have a good deal of outliers.
The financial industry ran into trouble not because the math was wrong, but because the people in charge didn't understand the math. But, Taleb has a sexier argument if he can blame a highly sophisticated academic discipline. I think that's called throwing the baby out with the bath water . . . .
I thought he was pretty fair
I thought he was pretty fair with mathematics, stressing the trade offs between what can be rigorously proven and what is actually true in the markets. How many math questions talk about interest rates as if they are constant, i.e. if John puts x dollars into the bank at r percent for 30 years how much will he have to retire? Now pick up a graph of bank rates for the last 30 years.
In math finance the Black Scholes pricing model taught to MBA's assumes no jumps, if you take a PhD bounded jumps are introduced for the martingale calculus. How big are the jumps in reality nobody knows. There has been an exponential explosion in the number of math finance PhD programs always with the selling point of being applied and tied to the Wall Street. One should expect that the deep theorems proved in this area have assumptions which hold in the real world are not just in an academic journal. One doesn't see airplane engineers saying their designs would be correct mathematically if air resistance didn't exist.
One of Taleb's main points is in fact that the word 'outlier' is itself a bad idea and one has no idea if the 'outliers' are actually the interesting part of a data set. In this respect he is just repeating ET Jaynes who argued against filtering data to a model. Certainly for agronomy, psychology, insurance etc. traditional statistics work well, but increasingly complicated systems first need to be understood qualitatively before quantitatively.
Mathematics and Statistics
I was hoping to see an actual argument against Taleb's idea expounded in The Black Swan. Instead, all I get is some idea about how since others can make money, maybe he is wrong. Ridiculous.
Here's a better question Mark. Is Benoit Mandelbrot wrong? Talk to some mathematicians and statisticians who are actually grappling with figuring out the truth of things and not making money about the ideas of Godel and the like. Then get back to us people trying to figure things out as opposed to those who only want to give their bosses a number they will like.
I expect a defense of Gaussian-like distributions will be the next thing posted here.
Sheer idiocy
You're right to be embarassed to be arguing against Nasim Taleb. His primary argument is that unexpected/catastrophic events (like the 1987 crash, the Dot-com crash and the 2008 crash) are far more common that most people think. A cool $10M to $30M every decade or so? Not bad in my book. How is your portfolio looking these days? Similar? I didn't think so.
It is about the Risk
Nassim Taleb's advice sounds like that reported from Peter L. Bernstein in his WSJ obit this weekend: "He counseled investors to take big risks with small amounts of money rather than small risks with big amounts of money. The same focus on the consequences of error was one of the main themes of "Against the Gods," which he published more than a quarter-century later. Also in 1970, Mr. Bernstein wrote: "We simply do not know what the future holds." Over the ensuing decades, he returned again and again to that phrase in his speeches, articles and books, because he felt it captured the central truth about investing." Nassim Taleb was not the first with these ideas about how to deal with market risk, but he did try to alert people to what he saw .
I read The Black Swan in 2007, but I did not truly understand the risk. My portfolio was small, so proportionally, my losses were small. I held on too long. I do have a bit more understanding now and I'm only 62.
As I see it, Taleb's strategy could work for him because there was so much risk that the market brains did not understand or seem to care about, that he couldn't miss. Hundreds of deer cross a road every night. There's a road kill every few months. Taleb could make small bets on market failure for years and have a high probability that he would win.
Small players can't do that very effectively. If you use a 7% figure with $10,000 you are betting big with just $700; or $7,000 on $100,000. It is very conservative. One has to save hard to get to these levels. In the U.S., saving has not been rewarded for decades, so people have been taking more and more risk, mostly unknowingly.
Financial system manipulation has been described as favoring borrowers and speculators over savers. Savers were forced into the stock market by the 401K and IRA legislation. Compounded returns of 7% or more a year would make us all rich. The competition for assets certainly inflated the market values and somehow lowered interest rates too. That wealth disappeared and reappeared several times, thanks to cheap money fixes.
The Stock Market crash was not a Black Swan to those who could understand the fragility of the debt relationships. We little people are not able to see these risks, even when told by people like Nassim Taleb, Peter Schiff or Bill Bonner. None got it totally right, but all saw something coming.
Boom psychology sweeps the herd along. Those that resist are ridiculed. The smugness of the herd and the herders is hard to deal with, particularly when even idiots are making money. It seems there's no other game in town.
Now the market is bi-polar market, swinging up and down. Buy and hold investing appears futile. There is only trading and it is too risky now. Some people will make money for sure. Some by luck, some by skill.
Roubini used the term "gambling for redemption" to explain the increased bets as the system got shakier. Some understand that the market is not a casino. There is no House that manages table play so payout risk doesn't break its bank. Redemption is perhaps a return to 1950's saving.
Taleb was right and is still right. The fact that some people will make money in the market does not make him wrong.
We the people will pay for the misallocation of capital through taxpayer funded programs, high fees relating to any financial service and probably inflation.
There will be other extreme events in the world. Humanity's resilience will be tested.
The savers who support the financial system should be protected from gamers. There's a slow food movement. I think a slow capitalism movement might make sense as well.
Fast money is too good to be true.