Monday, April 12, 2010

Black Swan...

David Usher writes a blog on which he muses about technology, telecommunications, public policy, regulation, society, media, war, culture and politics. He suggested I read "The Black Swan, The Impact of The Highly Improbable" by Nassim Nicholas Taleb. (You can find David's blog at The book led to this fairly ridiculous correspondence between me and my brother in law the stock market guru whose most recent stock pick is Radio Shack (symbol RSH):

I replied to Bro-In-Law;

"I have, as you know, given up (for the most part) trying to either time the market or pick individual stocks on either a fundamental or technical basis.

Your recent suggestion, Radio Shack, (RSH) does seem to be trying to rebrand itself but I think it faces challenges. It is a nice store for small products when you want to talk to a salesman without the hassle of Best Buy hugeness but the Shack's salespeople are usually not very up to speed. I could see them improving by cutting out their poorly performing stores. I think of them as the electronic version of Starbucks, they have lost their way and are trying to get back to what they do well - they may succeed. I would be reluctant to be long on options now because the market seems over heated to me (but what do I know)?

I just finished reading Black Swan which I think agrees with your investment thesis. To sum it up, as I understand it, Black Swans are events that do not appear anywhere on the Bell Curve proving that the Bell Curve itself is inadequate as a model yet is widely utilized to this day (Black Scholes for example is premised on a bell curve methodology). Bell Curves work in predicting the range of possible outcomes of heads or tails (40 heads in a row is on the far end of the curve) but does not work for complex outcomes where the impact of one variable has a wide range (and ever widening as you move out in powers) of impacts on future outcomes (like the angle of a ball bouncing - the range of angle is further multiplied with each subsequent bounce. Thus all models that are based on the Gaussian Bell Curve are terrific for predicting likelihood of unrelated events but flawed for predicting events that are not independent of one another (which is how the real world works unlike flipping pennies). As Nassim Taleb says, "Remember that if either of these two central assumptions is not met, your moves (or coin tosses) will not cumulatively lead to the bell curve. Depending on what happens, they can lead to the wild Mandelbrotian-style (fractal !!! emphasis mine) scale-invariant randomness." (page 251).

Interesting - way over my head but confirms my belief that insurance companies had no business issuing credit default swaps to guaranty citi bank debt on Pachinko Parlors in Japan (which they did - see

The converse, "White Swans", can happen to the upside as well so Taleb's view is that investors should put most of their money in Treasuries and buy small amounts of options to take advantage of the unpredictable on the upside while limiting the unpredictable downside events by not buying too much of any one option."

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