Nassim Taleb has released a paper with the IMF: A New Heuristic Measure of Fragility and Tail Risks: Application to Stress Testing
From Business Insider: NASSIM TALEB: The Fed Is Looking At The Banking System All Wrong
Nassim Taleb has long been a critic of traditional forecasting methods like the ones underlying these stress tests. He even coined a now oft-repeated term to capture his criticism – “black swan” – which became a huge New York Times bestselling book.
Now, he warns that “fragility is especially high for the banks with the worst outcomes” according to a new metric he’s developed to better analyze the risks facing the banks.
In a new white paper with researchers at the IMF, Taleb explains the reason why all of the stress tests conducted by central banks and international financial institutions like the Federal Reserve, the ECB, and the IMF come up short:
First, many stress tests focus on the point estimates of very few scenarios, and often pay little attention to how the impact would change in case of different scenarios, e.g., a slightly more severe one. Second, if stress tests do not take into account the possibility of model and parameter error, it can be misleading to rely only on the point estimates of even well-designed stress tests. Without considering the potential for these errors, one could miss the convexities/non-linearities that can lead to serious financial fragilities.
A better approach, according to Taleb and his IMF co-authors Elie Canetti, Tidiane Kinda, Elena Loukoianova, and Christian Schmeider, is to measure the difference between outcomes arising from different scenarios instead of focusing on the estimates of potential losses themselves.
According to Taleb, this is the real way to measure the “fragility” of a bank or a country in the event of a negative economic shock. Because point estimates are so prone to errors from faulty model assumptions, measuring the distance between them to detect how quickly losses pile up as the economic shock gets larger becomes a vastly more reliable measure of risk.
In other words, it’s not the size of the losses themselves that is important. Instead, it’s the rate of change of potential losses as the economic situation deteriorates that determines how fragile a bank is, by Taleb’s standards.
Nassim Taleb has released a technical note for Antifragile on his Facebook Page: Why the One Percent of the One Percent benefit from inequality more than general prosperity: A Note for AntiFragile.
The one percent of the one percent of the population is vastly more sensitive to inequality than total GDP growth (which explains why the superrich are doing well now, and should do better under globalization, and why it is a segment that doesn’t correlate well with the economy). For the super-rich, one point of GINI causes an increase equivalent to 6-10% increase in total income (say, GDP). More generally, the partial expectation in the tail is vastly more sensitive to changes in scale of the distribution than in its centering.
Sellers of luxury goods and products for the superwealthy profit from dispersion more than increase in total wealth or income. I looked at their case as a long optionality, benefit-from-volatility type of industry.
Another business that does not care about the average but rather the dispersion around the average is the luxury goods industry—jewelry, watches, art, expensive apartments in fancy locations, expensive collec – tor wines, gourmet farm – raised probiotic dog food, etc. Such businesses only cares about the pool of funds available to the very rich. If the population in the Western world had an average income of fifty thousand dollars, with no inequality at all, the luxury goods sellers would not survive. But if the average stays the same, with a high degree of inequality, with some incomes higher than two million dollars, and potentially some incomes higher than ten million, then the business has plenty of customers—even if such high incomes were offset with masses of people with lower incomes. The “tails” of the distribution on the higher end of the income brackets, the extreme, are much more determined by changes in inequality than changes in the average. It gains from dispersion, hence is antifragile.
This explains the bubble in real estate prices in Central London, determined by inequality in Russia and the Arabian Gulf and totally independent of the real estate dynamics in Britain. Some apartments, those for the very rich, sell for twenty times the average per square foot of a building a few blocks away.
Harvard’ s former president Larry Summers got in trouble explaining a version of the point and lost his job in the aftermath of the uproar. He was trying to say that males and females have equal intelligence, but the male population has more variations and dispersion (hence volatility), with more highly unintelligent men, and more highly intelligent ones. For Summers, this explained why men were overrepresented in the sci – entific and intellectual community (and also why men were overrepre – sented in jails or failures). The number of successful scientists depends on the “tails,” the extremes, rather than the average. Just as an option does not care about the adverse outcomes, or an author does not care about the haters.
Link: http: // www. fooled by randomness. com/ Onepercent. pdf
A reader has sent in a copy of Nassim’s Lecture notes from when he was teaching a course at the University of Massachusetts, Amherst, MA in 2005. The course/lecture series are titled: Randomness, Decisions, and Human Nature (SOM 797R – SYLLABUS).
Unfortunately all the links within the PDF are missing, if anyone has a copy with all the working links to studies, research papers, books, articles, images, etc, please let us know!
>> Check it out here.
Nassim Taleb will be speaking at the University of East Anglia as part of their 2012 Philosophy Public Lecture Series on Philosophy and the Economic Crisis.
The talk is scheduled for Thursday 27th of September 2012 and is titled “Opacity, Asymmetries and Ethics”. It will be held in LT2 and begin at 6.30pm, and is free to attend for all.
See here for the website and contact information:
http: // www. uea. ac. uk/ phi/ eventsnews/ public lectures/ public- lectures-2012
Nassim has just posted on his Facebook Page a 3-page PDF titled: Why It is No Longer a Good Idea to Be in The Investment Industry.
A spurious tail is the performance of a certain number of operators that is entirely caused by luck, what is called the “lucky fool” in Taleb (2001). Because of winner-take-all-effects (from globalization), spurious performance increases with time and explodes under fat tails in alarming proportions. An operator starting today, no matter his skill level, and ability to predict prices, will be outcompeted by the spurious tail. This paper shows the effect of powerlaw distributions on such spurious tail.
Unique Coverage/Mentions Around the Web:
The Wall Street Journal (MarketBeat Blog): Nassim Taleb: Stay Out of the Investment Industry
TIME.com (Investing): Nassim Taleb: In the Investment Biz, Luck Trumps Skill, So Take Your Talent Elsewhere
CNBC: Nassim Taleb: Stay Out of Finance!
Business Insider: NASSIM TALEB WARNS: Stay Out Of The Investment Industry.
Streetcoup: Nassim Taleb: Aspiring Money Managers Will Fail
reddit: “Black Swan” Author Nassim Taleb: Stay Out of the Investment Industry
Mindful Money: Nassim Taleb – Why you should avoid the investment industry
Nassim Taleb on Twitter (@nntaleb):
WSJ TOTALLY misreprsntd: my paper NOT abt “lucky fool” (old) but about the effect of fat tails and globalization; only @felixsalmon got it
Felix Salmon: The secret to success in the arts
More here, here, here, here, here, and here.
Nassim Taleb will be speaking at an upcoming Author Event held by the Free Library of Philadelphia (FLP) on Thursday, November 29, 2012 at 7:30PM.
The cost is $15 for General Admission, and $7 Students ($USD) and is on at Central Library (1901 Vine Street, Philadelphia, PA 19103). The talk coincides with the release of his new book and bears the same title: Antifragile: Things That Gain from Disorder.
View the event on the FLP Website.
The Green Lumber Problem, outlined in Nassim Taleb’s upcoming book Antifragile, is essentially misunderstanding which facts are relevant vs those which are not in regards decision making under uncertainty.
“In one of the rare noncharlatanic books in finance, descriptively called What I Learned Losing A Million Dollars, the protagonist makes a big discovery. He remarks that a fellow called Joe Siegel, the most active trader in a commodity called “green lumber” actually thought that it was lumber painted green (rather than freshly cut lumber, called green because it had not been dried). And he made a living, even a fortune trading the stuff! Meanwhile the narrator was into theories of what caused the price of commodities to move and went bust.
The fact is that predicting the orderflow in lumber and the price dynamics narrative had little to do with these details —not the same ting. Floor traders are selected in the most nonnarrative manner, just by evolution in the sense that nice arguments don’t make much difference.”
Here is a public discussion about the topic on his Facebook Page (Facebook account not required).
Just spotted Nassim Taleb’s upcoming book Antifragile on Penguin Books UK website. The website shows a different cover to the stacked boxes in the post below, and has a different subtitle “How to Live in a World We Don’t Understand” which would presumably be for the UK market. Publish date appears to be 27th of November 2012.
Antifragile: How to Live in a World We Don’t Understand
http:// www. penguin. co. uk/ nf/ Book/ BookDisplay/ … .html
In his global bestseller The Black Swan, Nassim Taleb explained the existence of high impact rare events beyond the realms of normal expectations. In his new book, Antifragility, Taleb goes much further. He tells us how to live in a world that is unpredictable and chaotic, and how to thrive during moments of disaster. Antifragility is about loving randomness, uncertainty, opacity, adventure and disorder, and benefitting from a variety of shocks. It is a new word because it is a new concept.
Many of the greatest breakthroughs in human endeavour come from the trial and error that is part of antifragility. And some of the best systems we know of, including evolution, have antifragility at their heart. Medicine, economics, even politics, could all be improved by embracing it. Our failure to realize this has even led to many huge historical misunderstandings about religion and belief.
So, how can we take advantage of antifragility? Taleb ranges over ideas and real-life situations, from why debt brings fragility, to why if we lose nothing we will gain nothing, to show that chaos makes us human. The most successful of us, the most daring, relentless and creative will take advantage of this disorder and invent new, more powerful opportunities and advantages beyond our expectations.
Nassim has currently uploaded for free viewing the Prologue of his upcoming book Antifragile: Things That Gain from Disorder.
Click here to check it out.
Antifragile joins the previous works of Nassim’s continued exploration of the concepts of risk, uncertainty, probability, and decision making (plus many others threads), all under the umbrella of how to live in a world we don’t understand. “It’s all the same book” he has said before. I appears he has turned his works into a trilogy of sorts The INCERTO (The Works on UNCERTAINTY: Antifragile, The Black Swan, Fooled by Randomness,The Bed of Procrustes), which a snippet about from the Prologue is below:
INCERTO, an investigation of luck, uncertainty, probability, human error, risk, and decision-making under opacity, expressed in the form of personal essay with autobiographical sections, parables, philosophical, historical, and scientific discussions in non-overlapping volumes that can be accessed in any order.
Antifragile cannot come soon enough!
EDIT: He is also currently allowing the viewing of Notes, Afterthoughts, and Bibliography, and also the Appendix I and Appendix II (these are draft versions and therefor “cannot be disseminated or quoted.” so these are linked to the originals and may be removed at any time (hint: save them quckly!))
Nassim recently did a short opinion piece in the The New York Times Room for Debate area titled Throw Out the Probability Models (April 2012).
It covers his typical Black Swan message that we cannot predict these certain class of rare but consequential events and so we need to become robust to them rather then relying on forecasts. The economic models that we use to calculate the probability of these rare events needs to go out the window.
“What goes out of the window? The entire discipline of modern finance and portfolio theory (the theories named after Harry Markowitz, William Sharpe, Merton Miller), the model-based methods of Paul Samuelson, much of time series econometrics (which don’t appear to predict anything), along with papers and theories that are based on “optimization.” These bring fragility into the system.”
Click here to read full piece here together with a reader discussion taking place in the comments section.