Black Swan

I was watching this program on a business channel last week (I rarely commit such a sin, but it was one of those days) the program was on: "How markets will behave in 2010", with great dismay I watch an expert talk (with great authority) that the market will cross 20k in 2010. The market will need a lot of Bull (pun intended) to cross 20k, the man was doing his bit. I am sure you have the same feeling of dismay while you switch to one of those news channels and hear the pundits predict a poll outcome.

I have seen the head of sales and marketing of my company make a series of calls to his contacts at critical client organizations and conclude and report back that we are not going to be severely affected by the slowdown, of course he was wrong, we were not spared and neither were our clients (this was in 2000 - 01). We have seen this happen over and over again, especially in the current globalized economy, Chaos Theory rules. A butterfly flap in New York will crash (or push up) the markets in Tokyo. We have seen many predictions and decisions based on past data/experience going awry in business and in our day to day life. This is the theme of Black Swan, a multimillion copy seller by Nassim Nicholas Taleb.

Nassim Nicholas Taleb is an extremely complex character, he is the grandson and great grandson of former deputy prime ministers of Lebanon (his grandfather and his great grandfather were both deputy prime ministers of Lebanon), he is a mathematician who prefers to call himself a philosopher, had a short career as a trader and investment banker in many leading banks (although, he is very skeptical about the many models used for trading). Later he started Empirica a hedge fund that trades in options and then retired from trading in 2004 (he continues to be an adviser for Empirica) and incidentally Empirica made a few billions during the recent market crash. He is a distinguished professor and of course he is the author of hugely successful books, Fooled by Randomness and later Black Swan. He has sold more than 2.7 million copies in some 31 languages. He never watches television and never reads newspaper! Hope I covered the many facets of Taleb. Here is a write up by Malcolm Gladwell on Taleb (this write up is also a part of the new book by Gladwell titled "What the Dog Saw").

Taleb strongly believes (and I would agree) that we lack the ability to predict events that are rare but have great impact, he states that there is no difference between the person in a position of power ( A deputy prime minister of Lebanon) and his car driver when it comes to knowing the way events are going to play out. Both believed that the Lebanon war would end soon, but it took 15 years when you look at most of our ministers you would readily agree. The difference is that the qualified think that they have some privileged info and the unqualified does not think so and puts the burden on fate/God.

Taleb talks about Inductive Reasoning and why it will fail, the title of the book is a good example of inductive reasoning. Let me explain, since people in Europe had never seen a black swan, they thought all swans were white. In fact there used to be a terms about Black Swans that people used when they wanted to refer something improbable (I would rather see a black swan before I see you coming on time!) and the sighting of a single black swan in Australia blew away the belief held for centuries. Inductive reasoning is generalization, we tend to generalize with specific set of (past) data and when this generalization proves to be wrong, it is often with disastrous results. Mike Gatting had seen many spinners before and Australia is not a country that has produced decent spinners in the past (Rajan to confirm). He would have thought that this is yet another bloke from down under and this first Warne delivery against England (known as the Ball of the Century or the Gatting Ball) was a complete Black Swan, the look on Gatting’s face was priceless.

Black Swans can bring good fortune too; the explosion of IT in India is a Black Swan - at least for the many graduates who passed out after 1991.

Black Swan events are random, hard to predict and rare events that create high-impact (Outliers). Taleb, defines black swans as below:
1. Hard to predict (based on historical information)
2. Has disastrous effect
3. Explained after the occurrence of the event by experts.

This has not been an easy book for me... but it is entertaining never the less and been an information overload and introduced many useful terms for sure : platonicity, narrative fallacy, modernistan, falsifiability; to name a few). I found the style to be contentions, probably a bit too aggressive and egoistic. The (repeated) digs he has at the cost of many economists and statisticians are at times in poor taste, so are his digs at the French.

Taleb also gives 10 points/principles to a Black Swan proof world, can be read here with description. Giving below some that I liked a lot:

• No socialization of losses and privatization of gains.
• People who were driving a school bus blindfolded (and crashed it) should never be given a new bus.
• Counter-balance complexity with simplicity.
• Do not give children sticks of dynamite, even if they come with a warning .
• Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”.

In our everyday life we come across many Black Swan events and hence it is important to approach each day with a fresh perspective and leave behind preconceived notions.

Try this (from the book):
All Snoogles are Boogles.
You see a Boogle.
Is that a Snoogle?

Spend a minute and you will get it. I tried this on my daughter and explained here the logic and it was an interesting experience, she thought that I had finally gone crazy completely:-)

The answer is 'may be'.

Outliers - 2

Successful men are shaped by a.) The Eco system that supports them and b.) the individuals, good old, hard work. These two things make them what they are (successful). There is no such thing as a genius making it on his own with limited efforts (probably the only exception is the case of one Swiss patents office clerk named Albert Einstein).

Accumulated Advantage - Gladwell, in the opening chapter talks about the Canadian (ice) hockey team and how most of the players in the national team were born in the first quarter of the year (Jan-Mar). This is because the cutoff date for joining the junior’s team is Jan 1. Boys who turn 10 by Jan 1 are in the same team as boys who turn 10 in the later part of the year; and hence have a greater physical advantage and outplay others. Obviously these guys are then groomed to be national players with superior coaching and opportunities and they just get better and better. I got intrigued by this theory and wanted to check on the current Indian Cricket player’s data, I was surprised to find that 62% of them are born in the last part of the year (Sep-Dec). Some cutoff theory working here too, I guess. The point is, if we recognize this bias, we can groom many top class players (from across the year). Gladwell calls this Bias as “the accumulated advantage”; you have the advantage of being born at the start of the year (or at the end of the year if you are in the Indian cricket team) and because of that get all the other advantages of good coaching and preference. It is not pure meritocracy.

The 10000 hour rule – This which pretty much says that if you want to excel in anything you need to put in at least 10000 hours of hard work on the stuff and hence fine tune your talent. He quotes Beatles and Bill Gates as examples. Beatles put in at least 10000 hrs of music (esp. between 1960 and 1964) and Gates had unlimited access to computers at School (it also helps if your family is already rich and funded many of those computer equipments). In all, it comes to at least 20 hrs of work in a week for 10 years and you will be a master in the chosen area.

Genius – Gladwell profiles Christopher Langan who has a super IQ of 195 (90-109 is normal and anything above 140 is considered to be Genius), but works as a bouncer (security guard at bars) and later settles in as a farmhand to take care of horses. Gladwell goes on to write what went wrong along the way and why Langan could not realize the full potential of his intellect, in spite of being the most intelligent man of America (world). The bottom-line is that the Eco system was not there to support him (he had a poor and difficult childhood) and also could not sustain the university system that is ill equipped to manage someone as exceptionally gifted as Langan.
This story of Langan is contrasted with that of Robert Oppenheimer; Oppenheimer being equally brilliant and equally emotionally unstable (he tries to poison his tutor at Cambridge). The difference is; Oppenheimer gets to be successful (Oppenheimer is known as the father of atom bomb and was heading the Manhattan project to develop an atom bomb during WWII (http://en.wikipedia.org/wiki/Manhattan_Project)) and this is not just because he is brilliant, but also has the right upbringing, his parents are wealthier, well connected and also let him grow intellectually by providing a nurturing environment.

The subsequent stories about early Jew immigrants in New York having a difficult life as tailors toiling many hours to make a living, but ensuring that their next generation move ahead and become successful lawyers, again focuses on the hard work and related reward, the culture and the unfolding of events (the boom in filing litigations and hostile takeovers).
Interesting chapter is “The Ethnic Theory of Plane Crashes”; in which Gladwell talks about the connection of culture to the number of plane crashes in a country. It goes like this: in a country which has a culture of respecting and not questioning authority – the number of crashes are high compared to a country that has little or no respect to hierarchy or question authority if required. What is happening in the cockpit is that the co-pilots fail to question or correct the captain’s critical decisions even if he feels that it is incorrect and this leads to crashes. An airline that encourages the culture of questioning authority, encourages a co-pilot to question a captain’s decision and this can avert a disaster. There is a great body of work done by Geert Hofstede

Outliers - 1

In statistics, an outlier is an observation that is numerically distant from the rest of the data. (Wikipedia)

When you get a set of data; there is a possibility that some part of it will have a large deviation from the mean (average), these observations or data is known as Outliers. Like a couple of IIM’s grads getting multi crore offers from Investment Bankers (not anymore, most IIM grads will now apply to SBI and Bank of Baroda, I guess) while the average salary of a fresh IIM grad is around 15 lakhs per annum. I am sure you get the picture now and will be able to identify the outlier in the graph on the left.

Outliers are usually ignored in a stats analysis as it is generally considered to be an error in observation or the knowledge that the mean can get much skewed because of these outliers (sometimes it is preferred; as in the IIM case, the media hypes the mean salary so much, just by including these couple of outliers). Even if it gets ignored for various reasons, an outlier nevertheless gets utmost attention (like the lone spot in the graph grabs our eyeball) and investigation.

Outliers is also the title of new book (Nov 2008) by Malcolm Gladwell, Gladwell has written 2 blockbusters before – the tipping point (2000) and the blink (2005), both the books sold over 2 million copies (compare that to Tamil writers who sell about 5000, i guess and mostly to libraries, thankfully the trend is getting better). Gladwell also commands more than 40000USD for any appearance (according to The New York Times). Outliers debuted as the number 1 seller on New York Times and has remained there for 18 weeks (http://www.nytimes.com/2009/04/05/books/bestseller/besthardnonfiction.html). That is big. Gladwell is the current blue-eyed boy of many corporates and he gives speeches at all the top corporations (like Google, Microsoft, etc). You can catch a sample of Gladwell’s skills at Ted.com - BTW, if you have not added Ted.com to your favorites than you are missing out on something and should add immediately. (http://www.ted.com/index.php/talks/malcolm_gladwell_on_spaghetti_sauce.html)

“Outliers” has a simple (intuitive for most of us) message; that success is not an individual’s show and there is no short cut to success (writing a book like this is an exception!).

... To Be Continued