Black Swan Blindness Redux
Humans have an ingrained tendency to underestimate outliers (Black Swans), but this miscalculation is fragile and can also involve severe overestimation when salient images are involved. The error rate for estimating the probability of rare events grows monstrously as the event becomes more remote, a phenomenon the author calls 'epistemic arrogance'.
THE IDEA
Black Swan Blindness Redux
The simple test above suggests the presence of an ingrained tendency in humans to underestimate outliers—or Black Swans. Left to our own devices, we tend to think that what happens every decade in fact only happens once every century, and, furthermore, that we know what’s going on.
This miscalculation problem is a little more subtle. In truth, outliers are not as sensitive to underestimation since they are fragile to estimation errors, which can go in both directions. As we saw in Chapter 6, there are conditions under which people overestimate the unusual or some specific unusual event (say when sensational images come to their minds)—which, we have seen, is how insurance companies thrive. So my general point is that these events are very fragile to miscalculation, with a general severe underestimation mixed with an occasional severe overestimation.
The errors get worse with the degree of remoteness to the event. So far, we have only considered a 2 percent error rate in the game we saw earlier, but if you look at, say, situations where the odds are one in a hundred, one in a thousand, or one in a million, then the errors become monstrous. The longer the odds, the larger the epistemic arrogance.
Note here one particularity of our intuitive judgment: even if we lived in Mediocristan, in which large events are rare (and, mostly, inconsequential), we would still underestimate extremes—we would think that they are even rarer. We underestimate our error rate even with Gaussian variables. Our intuitions are sub-Mediocristani. But we do not live in Mediocristan. The numbers we are likely to estimate on a daily basis belong largely in Extremistan, i.e., they are run by concentration and subjected to Black Swans.
When to use it
Anticipating black swans in macroeconomic forecasting.
Stress-testing a business model against improbable supply chain disruptions.
Personal financial planning (e.g., underestimating the likelihood of career upheavals or market crashes).
FROM THEORY TO EVERYDAY LIFE
In practice
Investing in Startups
A venture capitalist might dismiss a startup's chance of becoming a massive success (a 'unicorn') as too improbable to fund, severely underestimating the concentrated nature of returns in the tech industry (Extremistan). This is an example of underestimating a Black Swan.
Insurance and Natural Disasters
After a rare but highly sensationalized catastrophic earthquake, insurance companies might drastically overestimate the probability of another similar event occurring in the near future, raising premiums across the board for a risk that remains exceedingly low. The text describes this as 'occasional severe overestimation'.
A MOMENT TO REFLECT
Put it to work.
How does knowing you are predisposed to underestimate rare events change the way you evaluate long-shot risks and opportunities?
The text argues our intuitions are 'sub-Mediocristani'. Can you identify a recent decision where you treated the world as more predictable and stable than it actually is?
If 'the longer the odds, the larger the epistemic arrogance,' what can you actively do to combat this arrogance when planning for the distant future?
Often confused with
References
- The Black Swan — Nassim Nicholas Taleb (2007)
CONTINUE THE CONVERSATION
Source texts
- The Black Swan The Impact of the Highly Improbable With a new section On Robustness and Fragility (Nassim Nicholas Taleb)