What Are Black Swans?

I am sure that you have heard the term “Black Swan”. You are probably even aware that it originates in the book with the same name written by now famous and respected Nasim Nicolas Taleb. This American statistician and financial mathematician – he is prominent in some other areas, though – got worldwide attention and undisputable respect for revealing the importance of Black Swans through the impact they deliver to our lives. In this book, however, I would like to summarize the major ideas and facts about the so-called “Black Swans”.

Even if you have heard about the book, you may still lack clarity on why this writing is important. Let’s look at the credential Nasim Taleb’s book has received as of now. Despite being produced not so far ago – in 2007 – the book has its very notable and bright weight in the hierarchy of literature. Namely, it is recognized as one of the 12 most important books since WW2 by the Sunday Times. A year later after the publication, The Times claimed Nasim Taleb to be "now the hottest thinker in the world" since he not only predicted the 2008 Global Crysis – but also managed to explain the matter via “fat tails” of the normal distribution curve – those are tremendously unlikely events that bring the biggest shocks and changed to our lives. The book, of course, has not been free from pieces of criticism and negative reviews from some specialists. However, this has been always the case for works that got entitled to huge attention and discussion.

Now, let’s proceed to the definition of the Black Swan event. The concept is effectively related to an event that we cannot foresee or projects since its nature is unknown or very novel to us. Black Swan event is the “unknown unknown” – we do not know the subject and we do not know that we do not know it. For a clear but somewhat robust example, consider the following: you slaughter a cow. This is a Black Swan event for the cow. First, before slaughtering the cow, you feed it very well – you give it the best treatment in a general sense - so that it gains considerable fat, etc. The cow, as a result of your good treatment toward it, does not know that it is about to get slaughtered – it has no reason to think that you are about to change your behavior concerning it. Also, the cow lives in the isolation from other cows you have slaughtered – it, hence, cannot even “imagine” that people tend to “use” cattle in this way. This is what Nasim Tleb puts like “Unkown Unkown”.?

For an event to classify as a Black Swan event, the features should be present. First, the event should be absolutely rare – it should be an outlier and lie at the “Fat Tails” of a probability distribution bell-shaped graph. For example, financial experts – the majority of them – were sure that major investment banks such as Goldman Sachs, Bear Stearns, Merrill Lynch, Morgan Stanley, and Lehman Brothers will be saved by the US government via Bailout since they are too big to fail. However, this time it turned out that the government no longer wanted to give a hand to financial institutions (for some reasons not related to Black Swans directly) – which was a rare event in the then prevailing way of thinking.

Second, the impact of an event should be exorbitant. In our 2008 Global Crysis example, the impact is seen to be huge because a lot of finance people lost their jobs, many people lost everything they managed to save up, and many bankrupt people decided to commit suicide. Even more than so, the impact on national economies was very pronounced – the growth rates of economies have recovered and matched pre-pandemic levels not so far ago in advanced countries. Several countries that were too reliant on the financial and banking sectors – such as Iceland – were hit hard tremendously losing up to half of their Gross Dometic Products (Iceland was fast to recover, though).?

Third, this unexpected and very impactful event should be logically explained retrospectively – we should be able to explain their nature looking backward in history. For example, we now see major reasons behind the 2008 Global Financial Disaster: very loose regulation of the financial sector which motivated big investment banks to engage in tremendously risky lending and borrowing activities. Now, we even see the inefficiency and flaws of what we used to consider more or less acceptable before the crisis. This is a hindsight bias The good thing is that the financial crisis is not likely to happen according to the 2008 scenario again. The bad part is that Black Swan events per se are not connected: our knowledge of 2008 is not a guarantee that we will not have financial Black Swans in the future – they will be different in root causes.?

In short, these features are the basics one should know about the Black Swan events. There are many other things related to Black Swan events noted by Nasim Tales such as the notion of Antifragility, to name a few. However, I think that they deserve their own paper space. Let’s better look at some historic events which are generally recognized as Black Swan events.?

Apart from the already mentioned Global Financial Crysis of 2008-2009/10, we can name many more examples. Some experts say that there have been over 40,000 documented examples of the Balck Swan event in history. A couple of days there was a memorable day for 9/11 which is a tragic but valid example of the Black Swan. Another example from 2001 is the Dotcom Crush – nobody at the beginning of the web hype could foresee so many losses related to online companies; the effect was huge due to numerous broken lives and now we see that it was very predictable – there was a mere bubble on the market. Other more interesting examples are the visit of US President Richard Nixon to China – a representative of a hostile political sphere for the US. The dissolution of the USSR is referred to by many historians as a Balck Swan. I think that things get a bit messy with that example but ok.?

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