The certainty of uncertainty in a fat-tail world.
An unsettling reflection on the uncertainty in this world and its impact on our lives.
The last time when I wrote the newsletter, we had just entered the most uncertain phase of our life. As time unfolds, we are witnessing things that we never had imagined. Even when we were going through the first wave of this pandemic, we had never imagined things will look this murky in just a few months after accepting the so-called “new normal” life.
Many of us have gone through unimaginable events at some point in time in our life. But as we survive in this world full of uncertainty, we will begin to explore a few unsettling articles across the internet. These articles will talk about the role of uncertainty in our lives and how not just to survive but also to grow in this fat tail world.
What is a fat-tail world? To understand the concept of a fat-tail world, we have to look at one of the concepts of probability which is more often used in the financial world. It's the theory of a normal distribution. But for the ease of understanding these concepts in the real world, let me put it like this, a normal distribution in real-world events assumes that given enough observations or say events, all the events that you will see will be distributed equally above and below the mean(expectations). About 99.7% of all variations fall within three standard deviations of the mean(expectations) and therefore there is only a 0.3% chance of an extreme event occurring.
Read it again. As the normal distribution says there is only a 0.3% chance of an extreme event occurring. Then why are we worried about these events which have just a 0.3% chance of occurring in the real life? Well, because these are the same events that we never prepare to accept, and to survive through it. And when something like these events happen which are rare in the theory, these are the same events that become the turning point in our lives.
For Centuries, the Old World agreed that all swans were white. That was of course until black swans were discovered off the coast of Western Australia in 1697 by Dutch explorers, demonstrating the fact that an absence of evidence does not equate to evidence of absence.
A Black Swan, as Taleb says, is an event, positive or negative, that is deemed highly improbable yet causes massive consequences when it happens. Black Swans are said to explain almost everything about our world, but we, and that includes so-called experts, are blind to them.
Read more about the concept of Black Swan here : Black Swan Theory 101
Why Do We Underestimate Black Swan Risks?
We tend to label, focusing on biased data that reaffirms our belief, we also tend to discount information that undermines our past choices and judgments (confirmation bias);
We construct stories to explain events and see events as stories, with logical chains of cause and effect due to illusion of understanding (narrative fallacy);
We overestimate one’s knowledge and focus too narrowly on one’s field of expertise (tunnel vision),
We ignore other sources of uncertainty and we mistake applying our concepts to situations where they don’t actually apply. (ludic fallacy).
We tend to ignore the silent evidence and focus disproportionately either on the failures or successes;
We are not programmed to imagine Black Swans;
“We humans are the victims of an asymmetry in the perception of random events. We attribute our successes to our skills, and our failures to external events outside our control, namely to randomness.”
― Nassim Nicholas Taleb, The Black Swan: The Impact of the Highly Improbable
How to prepare for the black swan events? Let’s discover more about the same in our next newsletter. Stay Tuned!!
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