The New York Times bestseller, The Black Swan: The Impact of the Highly Improbable, by Nassim Nicholas Taleb, is a product of its time, writes AMANDA WHITE.

That a book about mathematics and philosophy could be a bestseller may seem remarkable, but on examination of the topic it becomes less extraordinary, as this book is a panacea for many of America’s woes.

For one it lets us [humanity] off the hook for not being able to predict the dramatic turn of events that shape our political, cultural, religious and personal lives. Generally speaking the book, and the theory Taleb has developed over many years, is about uncertainty. A black swan is a highly improbable event with three principal characteristics: it is unpredictable, it carries a massive impact, and after the fact humans rationalise it to make it appear less unpredictable and random than it was.

The September 11, 2001 attacks are an example. [The term black swan comes from the ancient western conception that all swans were white and that black swans were a metaphor for something that could not exist.] At presstime Taleb’s book sat at number 10 in the New York Times category of Hardcover Business Best Sellers, which is currently headed by The One Minute Entrepreneur.

For the most part the book covers ground already upturned by the finance academic journals, but what it does do with flair is bring these academic thoughts to the mainstream. And the mainstream is loving it. In addition to sitting on the New York Times bestseller list for 17 weeks, The Black Swan was’s highest selling non-fiction book published in 2007.

Much of Taleb’s success can be attributed to the fact he is a clever writer, he tackles both complex mathematics and philosophy in a way that is accessible for the average punter. And he does it with a nice writing style. Consider: “It is quite saddening to think of those people who have been mistreated by history. There were the poetes maudits, like Edgar Allan Poe or Arthur Rimbaud, scorned by society and later worshipped and force-fed to school children.

Alas, this recognition came a little too late for the poet to get a serotonin kick out of it, or to prop up his romantic life on earth.” Taleb is the Dean’s Professor in the Sciences of Uncertainty at the University of Massachusetts at Amherst, Professor of Mathematics at New York University, Visiting Professor at the Universite Paris-Dauphine, founder of Empirica LLC, and in 2001 was inducted into the Derivatives Hall of Fame. Needless to say he knows what he is talking about.

As a derivatives trader he puts his money where his mouth is, and used Black Swans as the centre of his work philosophy. While unable to build a career betting on black swans, with the opinion there are not enough tradable opportunities, he avoided being exposed to them by protecting the portfolio against large losses.

In order to eliminate the dependence on randomness, Taleb focused on the technical inefficiencies between complicated instruments, and on exploiting these opportunities without exposure to the rare event. He is a co-director of the Decision Research Laboratory at the London Business School and one of its research programs, “We Don’t Quite Know What We Are Talking About When We Talk About Volatility”, examines fund managers making mistakes in defining volatility.

This research concludes that finance professionals, who are regularly exposed to notions of volatility, seem to confuse mean absolute deviation with standard deviation, causing an underestimation of 25 per cent with theoretical Gaussian (or normal distribution) variables. His research shows that in some ‘fat tailed’ markets the underestimation can be up to 90 per cent, but concludes that a lack of statistical knowledge does not appear to be the impediment, but rather a difficulty in translating a nonlinear measure into a real-world application.

In this book, too, he tackles distribution models and goes so far as to warn readers of “experts” who are charlatans who believe in bell curves, in which most distribution is to the centre – ordinary and knowable. Instead Taleb argues that in order to understand a phenomenon, the extremes need to be considered, particularly if they carry a cumulative effect.

In this way, he argues the unexpected is the key to understanding financial markets, but also more generally, to understanding history. And while on the surface it is true no one can look into the future, or indeed predict events that occur outside the square, the message for our industry may be that those that are aware that not all risks can be measured, predicted or accounted for, may be better off. In a time where risk measurement and budgeting is a key focus, isn’t it better to consider there are more risks than less?

Other papers Taleb has co-authored a the London Business School include: ‘Why We Have Never Used the Black-Scholes-Merton Option Pricing Formula’; ‘The Illusions of Dynamic Replication’; and ‘Finiteness of Variance is Irrelevant in the Practice of Quantitative Finance’.

His previous book – Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets – was selected by Fortune as one of “The Smartest Books of All Time” and was published in more than 20 languages. But the real skill in this latest book is his ability to convey these thoughts into words a layperson can understand. Still working in the trading business, Taleb is careful not to get caught up in the paraphernalia that can go along with high profile business positions.

He focuses on the technical, never attends business meetings, avoids the company of “achievers” and people in suits that don’t read books, as well as taking a sabbatical year for every three to “fill the gaps in my scientific and philosophical culture”.

This is one of the key messages from the book: to know what you don’t know, and that one of the only ways to do that is to take some time out to think. A practical example of how this might play out is for fund executives to ask funds managers whether they know what they don’t know. Are all risks measurable, how have they factored into their models the risks they are uncertain of? Surely honesty will help advocate transparency, or lack thereof.

Increasingly, as the market develops, it is more difficult being in the business of superannuation. Funds need to be abreast of the changing needs of members and how to satisfy those with appropriate products. The industry supply chain is evolving and funds’ roles are changing as investment banks, investment managers, consultants and inhouse investment teams all struggle for a new dynamic.

 At the same time fund executives are tackling product complexity and the costs of marketing and communication into their business. All of these things need perspective, and one way to achieve that is to take time out and philosophise.

This is why the book has a good message, because it challenges you to stop and think. A number of people in this industry regularly advocate “thinking time” (Jack Gray, Jeff Bresnahan and this magazine’s Greg Bright to name a few) and they all have success on their side.

Join the discussion