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Working Papers

Black Swans in Blue Suits

Working paper #662
Bowen H. McCoy

In his bestseller, The Black Swan, Nassim Nicholas Taleb recounts that, based on tens of thousands of observations in the Northern Hemisphere, it was always assumed that swans could be only white. Then a black swan was sighted in Australia, and the whole theory collapsed. Every assumption that we have about our world and its future is vulnerable to the black swan phenomenon—the unexpected event. “The world we live in is vastly different from the world we think we live in,” he writes. Taleb, who is a mathematical trader, applies this insight to the world of finance, which he characterizes as consisting of over-compensated men in blue suits living in a fantasy world in which the future can be controlled by sophisticated mathematical models and elaborate risk management systems. People underestimate these extreme future events because they are unimaginable until after they occur. Statistical modeling deals with “known unknowns;” black swans are “unknown unknowns.” We are asymmetric in our perception of random events, attributing our successes to skill and our failures to external events beyond our control-that is, to random chance.

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