Nassim Taleb and Daniel Kahneman: Black Swan Shows Fragility under Heavy Weight of Anchoring
The New York Public Library recently hosted a discussion between two of the current era’s leading thinkers about decision making under uncertainty: Nassim Taleb and Daniel Kahneman. Taleb is famous not only for being a retired options trader, but also for his books, The Black Swan: The Impact of the Highly Improbable, Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets, and Antifragile: Things That Gain from Disorder. Kahneman was awarded the Nobel Prize in Economics in 2002 for his pioneering work in charting out the many precepts of behavioral finance.
Interestingly, each man was asked to write a biography of seven words or less. Taleb described himself as: “Convexity. Mental probabilistic heuristics approach to uncertainty.” Kahneman apparently pleaded with the moderator to only use five words, which were: “Endlessly amused by people’s minds.” Not surprisingly these two autobiographies are descriptive of the two men’s bodies of work. Much of the discussion at this event, however, was not about making decisions under uncertainty, but a sort of tit for tat, with Kahneman asking probing questions and making pointed observations of Taleb. Little of the Nobel laureate’s work was discussed.
Taleb is well known for his description of black swans — events that seem almost impossible, but that nonetheless happen with regularity. Unfortunately, many in life, including financial professionals, often do not include the possibility for black swans in their assessments of the future and of its uncertainties.
Taleb focused on discussing his latest concept, antifragility, a bit of nomenclature legerdemain meant to describe things in life that gain from increasing disorder. Antifragility rounds out a continuum that he labels: resilience. On one end of the continuum are things Taleb describes as fragile — such as glass. In the middle of the continuum is the concept of robustness, and standing opposite fragile is the concept of antifragile.
To describe this idea, Taleb invoked the second derivative of calculus (i.e., acceleration). He stated that you can measure fragility by the acceleration of harm an object may absorb. An example would be hitting an object with a force, x, then measuring the damage done to the object. Next increase the force to 2x. If the damage done is greater than 2 times the amount of damage produced by the original force x , you can say that there is accelerating fragility.
While the concept may seem confusing, essentially Taleb’s antifragility may be distilled down to the idea that all systems need exercise. That is, systems need to suffer, just a little bit, in order to remain fit and ready for the uncertainties of the world. By contrast, though, most people do not seek a little bit of pain to maintain their sharpness, instead pursuing certainty and constancy — a point raised by Kahneman. In fact, Kahneman aptly stated that his own 40-year research career demonstrated that Taleb’s proposals run counter to human nature, and he expressed skepticism that antifragility concepts will be successfully implemented.
Taleb is well known for a parable he tells of a turkey (presumably in the United States) and of a turkey farmer. From the perspective of the turkey, the farmer is an absolutely wonderful character, providing endless food, adequate shelter, and ample opportunities for socializing with its kind — until the day the farmer slaughters the turkey for the upcoming Thanksgiving holiday. Kahneman criticized this story by pointing out that Taleb places extreme emphasis on black swan events. After all, every turkey dies, but these turkeys actually have a very good life for all of their days. Kahneman also thought that an explanation for Taleb’s intense focus on black swan events was due to one of behavioral economic’s chief findings: anchoring. In other words, Taleb is a man with a hammer for whom most problems look like nails.
Unfortunately, despite many such amusing exchanges, neither gentleman offered much practical advice for how to better make decisions under uncertainty or how investment professionals can apply the discoveries of behavioral finance. I recommend that those interested in a deep dive into behavioral finance consider the forthcoming event, Behavioral Finance: From Theory to Practice. Speakers at the 7–10 April event will include Michael J. Mauboussin and Jason Zweig. Early registration for this carefully crafted and curated event expires 15 February.
[Note: Dr. Gerry Wojnar suggested a correction – since applied – regarding the language used to describe Mr. Taleb’s use of calculus to describe how to measure anti-fragility.]
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