They Want to Live in Mediocristan

I have just presented the Black Swan problem in its historical form: the central difficulty of generalizing from available information, or of learning from the past, the known, and the seen. I have also presented the list of those who, I believe, are the most relevant historical figures.

You can see that it is extremely convenient for us to assume that we live in Mediocristan. Why? Because it allows you to rule out these Black Swan surprises! The Black Swan problem either does not exist or is of small consequence if you live in Mediocristan!

Such an assumption magically drives away the problem of induction, which since Sextus Empiricus has been plaguing the history of thinking. The statistician can do away with epistemology.

Wishful thinking! We do not live in Mediocristan, so the Black Swan needs a different mentality. As we cannot push the problem under the rug, we will have to dig deeper into it. This is not a terminal difficulty—and we can even benefit from it.

• • •

Now, there are other themes arising from our blindness to the Black Swan:

1. We focus on preselected segments of the seen and generalize from it to the unseen: the error of confirmation.
2. We fool ourselves with stories that cater to our Platonic thirst for distinct patterns: the narrative fallacy.
3. We behave as if the Black Swan does not exist: human nature is not programmed for Black Swans.
4. What we see is not necessarily all that is there. History hides Black Swans from us and gives us a mistaken idea about the odds of these events: this is the distortion of silent evidence.
5. We “tunnel”: that is, we focus on a few well-defined sources of uncertainty, on too specific a list of Black Swans (at the expense of the others that do not easily come to mind).

I will discuss each of the points in the next five chapters. Then, in the conclusion of Part One, I will show how, in effect, they are the same topic.

[*] I am safe since I never wear ties (except at funerals).

[*] Since Russell’s original example used a chicken, this is the enhanced North American adaptation.

[*] Statements like those of Captain Smith are so common that it is not even funny. In September 2006, a fund called Amaranth, ironically named after a flower that “never dies,” had to shut down after it lost close to $7 billion in a few days, the most impressive loss in trading history (another irony: I shared office space with the traders). A few days prior to the event, the company made a statement to the effect that investors should not worry because they had twelve risk managers—people who use models of the past to produce risk measures on the odds of such an event. Even if they had one hundred and twelve risk managers, there would be no meaningful difference; they still would have blown up. Clearly you cannot manufacture more information than the past can deliver; if you buy one hundred copies of The New York Times, I am not too certain that it would help you gain incremental knowledge of the future. We just don’t know how much information there is in the past.

[*] The main tragedy of the high impact-low probability event comes from the mismatch between the time taken to compensate someone and the time one needs to be comfortable that he is not making a bet against the rare event. People have an incentive to bet against it, or to game the system since they can be paid a bonus reflecting their yearly performance when in fact all they are doing is producing illusory profits that they will lose back one day. Indeed, the tragedy of capitalism is that since the quality of the returns is not observable from past data, owners of companies, namely shareholders, can be taken for a ride by the managers who show returns and cosmetic profitability but in fact might be taking hidden risks.

Chapter Five

CONFIRMATION SHMONFIRMATION!