Positive or Negative Black Swan?
Taleb distinguishes exposures that can benefit from rare surprises from those that suffer large losses. Historical observations may understate the downside of a negative exposure or miss the upside of a positive one.
THE IDEA
7. Positive or negative Black Swan?
Clearly the Fourth Quadrant can present positive or negative exposures to the Black Swan; if the exposure is negative, the true mean is more likely to be underestimated by measurement of past realizations, and the total potential is likewise poorly gauged.
Taleb argues that historical estimates of human life expectancy can miss the effect of a major epidemic under globalization. He claims that this loss could outweigh gains from cures, and makes a similar argument about returns on risky investments.
He contrasts this with research ventures, whose past results may omit a future breakthrough. In his comparison, a biotech company can have substantial upside uncertainty, while a bank’s exposure is dominated by downside shocks.
Model errors benefit those exposed to positive Black Swans. In my new research, I call that being “concave” or “convex” to model error.
When to use it
A venture capitalist evaluating early-stage biotech companies with potential for breakthrough drugs (positive Black Swan).
An insurance company setting premiums for life insurance, considering the risk of a major epidemic (negative Black Swan).
A financial institution stress-testing its portfolio for rare but severe market crashes (negative Black Swan exposure).
A research and development department in a technology firm investing in innovative projects with high upside uncertainty (positive Black Swan).
FROM THEORY TO EVERYDAY LIFE
In practice
Epidemic Risk and Life Expectancy
Taleb uses a major epidemic as an example of a downside event that may be missing from historical life-expectancy estimates. The passage does not quantify that effect or establish that it outweighs gains from cures.
Biotech vs. Bank Exposures
Taleb contrasts the possible breakthrough payoff of a biotech venture with the large-loss exposure of a bank. This is a comparison of payoff structures, not a claim that every biotech company benefits from uncertainty or every bank faces only losses.
A MOMENT TO REFLECT
Put it to work.
In your professional or personal life, are you more exposed to positive or negative Black Swans? How does this affect your decision-making?
How can you structure your investments or projects to be 'convex' to model errors and benefit from positive Black Swans?
Can you think of a situation where past data significantly underestimates risk because of potential negative Black Swan events?
Often confused with
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)