Sunday, 30 January 2011

Fooled by Randomness, by Nassim Taleb

The hidden role of chance

There is more chance in the universe than we acknowledge. Mr Taleb has meditated deeply and acted wisely on the implications of chance. In this book he shares with us the fruits of his eloquence and meditations and readings and experiences. A quotation from ‘Fortune’ on the front cover of my Penguin paperback describes this as “one of the smartest books of all time”. I agree – or at least within the limited universe of books I have chanced to read.

I read and reviewed this book in 2008, and the financial crisis was unfolding. Now, over two years later, with the financial crisis still burning in some underground patches and the forest fire of the sovereign debt crisis gathering force, I have felt impelled to read it again, and write on it more extensively. It strikes me a even more smart on a second reading. The author is smart in several senses: a high pure intelligence quotient; a stunningly wide knowledge of literature; the deployment of remorseless logic; creative lateral leaps between seemingly unrelated but truly interconnected topics; an ability to out-fence and de-throne revered figures or ideas; a wonderfully wide vocabulary; elegant writing style; a sharp street-wise roughness; an engaging sense of humour; the deft speed of a card sharp.

This man clearly is lucky enough to be endowed with the right genes of intelligence, as he would admit, and not hide with false modesty. This may strike some people as arrogance, but we need his forthright intelligence in some many dumbed-down fields. I defer to his intelligence and hope to pick up a few scraps of wisdom from his books. He has read widely books of classical civilisation, psychology, medicine, history, mathematics and many other categories of knowledge. Maybe his voracious reading efficiency is partly down to his self-discipline in avoiding the time-wasting ‘noise’ that pours from 24-hour TV ‘News’ and Economics. I plod slowly in his footsteps, and feel that he pats me on the head when I can claim some passing acquaintance with some of his reading, such as Montaigne.

He drops vocabulary for me to pick up. For instance: ‘Péché mignon’ – a guilty pleasure. He mentions this is describing his own and our universal humanity. We are not pure rational calculating machines, as assumed by many economic theories. We all have and need our guilty pleasures, whether they are chocolate or cigarettes or something far worse. He has flashes of wry humour, and more moments of self-depreciation that I had previously noticed. His outspoken attacks on stupid thinking had made a stronger impression when I first read this book. That is what I mean by a street-wise toughness; as well as the fact that he has been through the refining fire of a dealing room, where he succeeded, whereas I failed (though still benefited from the experience in the long run).

When I say he is a ‘card sharp’, I do not mean he is literally dishonest or even intellectually dishonest. He is quick –way ahead of most of us. I would not engage in a trading contest against him, for he would probably take money off most of us – in the long run.

In the short-run, as he explains, many things in life are dominated by chance. What we are seeing is randomness in action, and we are often fooled by it. The daily ticks up or down of the stock market reported on the news constitute pure noise. The variations of daily weather (even seemingly extreme snow or wind) cannot be said to constitute a climate pattern until many many years of data come in. The performance of football teams on a game by game basis has a high variability. Why sack a manager after a run of 10 bad games? The performance of a fund manager cannot be ascribed to any genius over the short run. It is frightening to consider how long that ‘short-run’ really is. Can you be sure that you have a genius fund manager after even 5 years (20 quarters) of performance data? Taleb would be very sceptical.

One of the most challenging aspects of the book is what he calls ‘The problem of induction’. Induction is the process of arriving at a general hypothesis from particular data. One can gather as much data as one likes, but it never proves anything with 100% certainty. He gives an amusing absurd example: “I have just completed a thorough statistical examination of the life of President Bush. For fifty eight years, close to 21,000 observations, he did not die once. I can hence pronounce him as immortal, with a high degree of statistical inference.”

We laugh, but we can observe versions of this fallacy all around us. “The market has never gone down 20% in a given three-month period”. We also attach too much importance to the immediate past, and what is in front of us: “It has been snowing for the past five days, so global warming is obviously a fallacy.” Also the opposite: “We have observed 10 of the hottest years in the past 20 of our records, so global warming is a certainty”. And so on.

Taleb explains succinctly the answer propounded by the great philosopher Karl Popper. He expresses it completely baldly as follows:
“There are only two types of theories: 1) Theories that are known to be wrong, as they were tested and adequately rejected; 2) Theories that have not yet been known to be wrong, not falsified yet, but are exposed to be proved wrong.”

By shifting the burden from verification to falsification, Popper gives us a whole new and adequate solution to the problem of knowledge. It is also deeply uncomfortable, and goes against our natural propensity to write stories about things, or to find causal links between things. Taleb recognises how difficult it is for all of us to keep rational amidst a cacophony of random noise and genetic instincts endowed to us by evolution, which is itself not concerned with rationality but survival of genes.

Having stripped away many of our illusions, one of the best things of the book is that he gives us some practical ‘tricks’ to overcome our human weaknesses, and made randomness work to our advantage. Want to know what those tricks are? Read the book! Actually, I find his prescriptions at the end the weakest part of the book: preaching stoicism in the face of fickle fortune may be wise, but some more practical suggestions might be useful. Maybe I am expecting too much.

Nassim Taleb is exhibit ‘A’ for advocating the virtues of a wide liberal education, fighting back the tide of stupid pseudo-scientists who increasingly dominate our world, unfortunately. I am sure many of you will agree that this is one of the smartest books of our time.


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