Fooled by Randomness

Dice

In all courses of life, avoiding a major catastrophe is probably good advice.  Nassim Taleb writes about the randomness of such events, dubbed Black Swans in his 2004 book Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets.  While a good portion of the book outlines his dealings on Wall-Street, they are used more for illustration on the underlying theme as opposed to a finance book.  In fact, Taleb mentions a few times that mathematics should be used more as a thought experiment than as a rigorous science.  It’s not for the lack of rigor in maths, rather the lack of rigor in real life and the randomness in which life events occur, that maths cannot sufficiently explain.

The book, broken into three parts, begins with Solon’s Warning.  The Greek King Croesus (595 BC – c. 546 BC) was visited by Solon, a Greek legislator.  The king, being full of self-worth, insisted that Solon acknowledge that he (the king) was the happiest man of all.  Solon replied:

The observations of the numerous misfortunes that attend all conditions forbids us to grow insolent upon our present enjoyments, or to admire a man’s happiness that may yet, in course of time, suffer change.  For the uncertain future has yet to come, with all variety of future; and him only to whom the divinity has continued happiness until the end we may call happy.

In simpler terms, it ain’t over ‘till it’s over. This pretty much sums up the first part of the book.  There are illustrious examples provided that help to mitigate the pain of the incompetent individual becoming greatly successful due to random chance and attributing it to their own skill.  In those examples, the incompetent’s skill eventually runs out, at least it did in the examples that stood out the most.

Taleb proposes that most things in life are more random and less skill, though we attribute to skill and fawn over those crafty enough to buck the average.  One example takes 10,000 fund managers, each year 50% of them will make $10,000 and 50% of them will loose $10,000.  Each year they loose they are fired.  The first year 5,000 managers made $10,000, the second year 2,500 remain, and so on until you have 312 remaining with 5 years of solid performance gains.  At this point, one or so of these fictional managers are interviewed by journalists, their life stories picked apart and every aspect of their life dissected to determine what part of their upbringing contributed to their great success.  All the while never acknowledging that simply random events possibly caused their success.

He pursues many fun side-stories, one of which discusses whether Microsoft Office is truly the best available software.  Academic market theory would suggest that if there was better software that others would buy it and either force Microsoft to improve their offerings or lose to the better product.  However, we know this to be false.  One uses Microsoft Office because the person you’re sending your document to uses Microsoft Office.  And they use it because of similar reasons.  Few people have the ability to choose the best product, often a monopoly can inhibit growth and never be viewed as a monopoly.

Part two of the book focuses on survivorship bias and probability.  Given infinite monkeys with (albite rather strong) typewriters, one will eventually pound out the complete Iliad.  Now, do we assume that this monkey is anything special?  Probably not, at least probabilistically.  What if there were 100 monkeys and one produced Hamlet?  Taleb insists that this monkey, coming from a much smaller sample, is probabilistically a better caliber of monkey than the rest.  What if you didn’t know how many monkeys were in the population?  If you’re only ever viewing the winners it’s hard to know if there were 1,000,000 monkeys or 10 and knowing how many monkeys there are makes all the difference.

Considering the proclivity for survivorship bias, how does one assess the skills required?  The ninth chapter is titled IT IS EASIER TO BUY AND SELL THAN FRY AN EGG.  To this point, a cook could not randomly present good, let alone editable food for very long if they knew little about cooking.  Randomly getting the correct mixtures of ingredients correct is hard to maintain.  The odds that a chef could stay a chef for any number of years without relying on skill is very improbable due to the skillful nature of their work.  A Trader or Investor, conversely, buy and sell securities or derivatives and can be very lucky for long periods of time.

He finishes up the book with part three, discussing that listening to too many experts is self-destructive.  He views unsolicited criticism with equal disdain.  It is within this portion of the book that the most humility presents itself.  In line with Charlie Munger, Nassim Taleb claims to know nothing for certain, only that he’s special because he knows that he knows nothing.  The best quip in this section relates to a politician who’s recently changed their viewpoint and was accused of lying:

Monsieur de Norpolis was not lying.  He had just forgotten.  One forgets rather quickly what one has not thought about with depth,  what has been dictated to you by imitation, by the passions surrounding you.  These change, and with them so do your memories.  Even more than diplomats, politicians do not remember opinions they had at some point in their lives and their fibbing are more attributable to an excess of ambition than a lack of memory.

The book finishes with a rather extensive collection of references and further readings.

The contents of this book can help you frame your mind around the often unpredictable and random happenstances of life and the effect those can have on your success or failure.  The central lesson here, “Never attribute to success that which is adequately explained by randomness” is a probabilistic view point of  Halon’s razor, “Never attribute to malice that which is adequately explained by stupidity.”  Perhaps we can call this Talab’s Razor.