Emergic: Rajesh Jain's Blog

Emergic: Rajesh Jain's Blog header image 2

TECH TALK: Fooled by Randomness: The Person

May 9th, 2006 · No Comments

Here is how Nassim Nicholas Taleb (NNT) describes himself and his interests on his website: NNT is only interested in one single topic, chance (particularly extreme & rare events); but it falls at the intersection of philosophy/epistemology (skepticism; knowledge about the dynamics of history; inferential claims), philosophy/ethics (stoicism facing random events; theories of nonhedonic happiness), mathematics (probability, statistical physics), social science/finance (opacity & incomplete information; why economists have no clue but think that they know a lot), and cognitive science (how we are fooled by randomness). He mainly derives his intuitions from a 2-decade long and intense practice of derivatives trading (nondull activities with plenty of randomness). The ideas are expressed in literary form in the trilogy: Fooled by Randomness (2001, 2004, 17 languages, confusion of luck & skills), The Black Swan (2006, epistemology/philosophy of history, history explained by large deviations),& Chance and the Logic of Happiness (c. 2007, ethics/ stoicism, nonhedonic happiness). Only the first book in the trilogy has been published.

This is the Wikipedia entry on Taleb:

Taleb now focuses on being a student of the philosophy of randomness and the role of uncertainty in science and society. When he was primarily a trader, he developed an investment method which sought to profit from unusual and unpredictable random events, which he called “black swans”. His reasoning was that traders lose much more money from a market crash than they gain from even years of steady gains; and so he did not worry if his portfolio lost money steadily, as long as that portfolio positioned him to profit greatly from an extremely large deviation (either a crash or an unexpected jump upwards).
It is important to note that “black swans” may also be fortunate rare events and not just negative or catastrophic events.

Taleb believes that most people ignore “black swans” because we are more comfortable seeing the world as something structured, ordinary, and comprehensible. Taleb calls this blindness the Platonic fallacy, and argues that it leads to three distortions:
1) Narrative fallacy. Creating a story post-hoc so that an event will seem to have a cause.
2) Ludic fallacy. Believing that the structured randomness found in games resembles the unstructured randomness found in life. Taleb faults random walk models and other inspirations of modern probability theory for this inadequacy.
3) Statistical regress fallacy. Believing that the probability of future events is predictable by examining occurrences of past events.

Here is an excerpt from the book (page 103, paperback) which describes Talebs trading philosophy:

The best description of my lifelong business in the market is skewed bets, that is, I try to benefit from rare events, events that do not tend to repeat themselves frequently, but, accordingly, present a large payoff when they occur. I try to make money infrequently, as infrequently, as possible, simply because I believe that rare events are not fairly valued, and that rarer the event, the more undervalued it will be in price.

Thinking about that made me think about what I am doing, but more on that a little later.

Tomorrow: The Philosophy

TECH TALK Fooled by Randomness+T

Tags: Tech Talk

0 responses so far ↓

  • There are no comments yet...Kick things off by filling out the form below.

Leave a Comment