Volatility and Risk of Black Swan
People often choose strategies that minimize visible volatility but carry the risk of large catastrophic losses, akin to collecting nickels in front of a steamroller. This trade-off also applies to careers and political systems, where apparent stability can mask fragility.
THE IDEA
Volatility and Risk of Black Swan
People are often ashamed of losses, so they engage in strategies that produce very little volatility but contain the risk of a large loss—like collecting nickels in front of steamrollers. In Japanese culture, which is ill-adapted to randomness and badly equipped to understand that bad performance can come from bad luck, losses can severely tarnish someone’s reputation. People hate volatility, thus engage in strategies exposed to blowups, leading to occasional suicides after a big loss.
Furthermore, this trade-off between volatility and risk can show up in careers that give the appearance of being stable, like jobs at IBM until the 1990s. When laid off, the employee faces a total void: he is no longer fit for anything else. The same holds for those in protected industries. On the other hand, consultants can have volatile earnings as their clients’ earnings go up and down, but face a lower risk of starvation, since their skills match demand—fluctuat nec mergitur (fluctuates but doesn’t sink). Likewise, dictatorships that do not appear volatile, like, say, Syria or Saudi Arabia, face a larger risk of chaos than, say, Italy, as the latter has been in a state of continual political turmoil since the second war. I learned about this problem from the finance industry, in which we see “conservative” bankers sitting on a pile of dynamite but fooling themselves because their operations seem dull and lacking in volatility.
When to use it
Portfolio management: choosing between assets that show steady returns but have tail risk (e.g., selling options) vs. assets that fluctuate but are less likely to wipe out.
Career planning: deciding between a job in a protected industry with low volatility but high risk of obsolescence vs. a more volatile career with transferable skills.
Political risk assessment: evaluating the stability of countries based on visible turmoil versus hidden fragility.
Business strategy: assessing a company that appears stable due to consistent earnings but may be exposed to disruptive innovation.
FROM THEORY TO EVERYDAY LIFE
In practice
Collecting nickels in front of a steamroller
A financial strategy that generates small, steady gains but carries the risk of a catastrophic loss. Traders may sell out-of-the-money options to collect small premiums, but if a black swan event occurs, they face huge losses.
Stable careers vs. volatile but resilient ones
Taleb uses corporate jobs before the 1990s to contrast apparently steady employment with consulting’s variable income. The underlying question is how many alternatives a person has if one employer or client disappears, rather than whether one career label guarantees resilience.
A MOMENT TO REFLECT
Put it to work.
In your career, are you trading visible stability for hidden fragility? Consider how specialized your skills are and what would happen if your industry faced a disruption.
Think of a financial investment you consider 'safe'. Does it have low volatility but potential for a large loss? How can you assess the tail risks?
How might the trade-off between volatility and risk apply to your personal life, such as relationships or health routines?
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)