Great new interview with Nassim Taleb by one of his former teachers at Wharton:
Taleb: The events in the Middle East are not black swans. They were predictable to those who know the region well. At most, they were gray swans or perhaps white swans. One of the lessons of “Wild vs. Mild Randomness,” my chapter with Benoit Mandelbrot in your book, is what happens before you go into a period of wild randomness. You will find a long quiet period that is punctuated with absolute total turmoil…. In The Black Swan, I discussed Saudi Arabia as a prime case of the calm before the storm and the Great Moderation [the perceived end of economic volatility due to the creation of 20th century banking laws] in the same breath. I was comparing Italy with Saudi Arabia. Italy is an example of mild randomness in comparison with Saudi Arabia and Syria, which are examples of wild randomness. Italy has had 60 changes in regime in the post-war era, but they are inconsequential…. It is a prime example of noise. It’s very Italian and so it’s elegant noise, but it’s noise nonetheless. In contrast, Saudi Arabia and Syria have had the same regime in place for 40 some years. You may think it is stability, but it’s not. Once you remove the lid, the thing explodes.
The same kind of thing happens in finance. Take the portfolio of banks. The environment seemed very placid — the Great Moderation — and then the thing explodes.
Herring: I would agree that people knew the Middle East was very vulnerable to turmoil because of the demographics, a very young population, and widespread unemployment, the dissatisfaction with the distribution of income and with regimes that were getting geriatric. But knowing how it would unfold and knowing that somebody immolating themselves in a market in Tunisia would lead to this widespread discontent — and we still don’t know how it will end — is a really remarkable occurrence that I think would be very difficult to predict in any way.
Taleb: Definitely, and it actually taught us to try not to predict the catalyst, which is the most foolish thing in the world, but to try to identify areas of vulnerability. [It’s] like saying a bridge is fragile. I can’t predict which truck is going to break it, so I have to look at it more in a structural form — what physicists call the percolation approach. You study the terrain. You don’t study the components. You see in finance, we study the random walk. Physicists study percolation. They study the terrain — not a drunk person walking around — but the evolution of the terrain itself. Everything is dynamic. That is percolation.
And then you learn not to try to predict which truck is going to break that bridge. But you just look at bridges and say, “Oh, this bridge doesn’t have a great foundation. This other one does. And this one needs to be reinforced.” We can do a lot with the notion of robustness.
(via Chris Arkenberg)