HOISTED FROM ÞE ARCHIVES (2015): Black Swans Roosting in Trees on Dunsinane Hill Blogging
It's not þt really unexpected things happen—it's þt we fail to understand, & hence fail to expect, þt normal variation will be as large as it is bound to be...
"Black Swans" Is the Wrong Way to Think About It: "Great Birnam Wood to High Dunsinane Hill Come" Weblogging...
Well, this is certainly surprising; this is certainly a black swan!:
Nassim N. Taleb, noted promoter of junk science, is now defending homeopathy <https://t.co/a7mHOTVgei> <pic.twitter.com/c3vpQnpxuh>
— Boing Boing (@BoingBoing) November 20, 2015
And it collides on my desk with (a) Shakespeare's Macbeth, and (b) my own grappling with how I have been very surprised by what did and did not happen to our policies and our economies since 2005...
So let's raise the curtain:
From:
William Shakespeare: Macbeth: "Thunder. Enter the three WITCHES...
...First Witch: Thrice the brinded cat hath mew'd.
Second Witch: Thrice and once the hedge-pig whined.
Third Witch: Harpier cries ''Tis time, 'tis time.'
First Witch: Round about the cauldron go;
In the poison'd entrails throw.
Toad, that under cold stone
Days and nights has thirty-one
Swelter'd venom sleeping got,
Boil thou first i' the charmed pot....Third Apparition: Be lion-mettled, proud; and take no care
Who chafes, who frets, or where conspirers are:
Macbeth shall never vanquish'd be until
Great Birnam Wood to high Dunsinane Hill
Shall come against him.Macbeth: That will never be.
Who can impress the forest, bid the tree
Unfix his earth-bound root? Sweet bodements! good!
Rebellious dead, rise never till the Wood
Of Birnam rise, and our high-placed Macbeth
Shall live the lease of nature, pay his breath
To time and mortal custom...
I have, in my minds eye, a scene—it probably never happened this way:
The young quant whippersnappers present a position to the senior partners. And then, when they have finished, one of them says:
Well, you have just convinced me that 'Macbeth shall never vanquish'd be until Great Birnam Wood to high Dunsinane Hill shall come...'
Now tell me: in what scenarios would Great Birnam Wood come to High Dunsinane? And what would be the value of our positions in those scenarios?
And they look at each other, catch one another’s eyes, and think: We're doing stochastic calculus. He's quoting Shakespeare? This is totes weird...
Yet, in my career, Great Birnam Wood has come to High Dunsinane Hill six times I can recall off-the-cuff:
Mexican peso: rich Mexican demand for New York bank accounts greater than U.S. firm demand for assets in Mexico secure against tariffs and quotas...
Mexican political economy: allowing imports of Iowa corn, bad as it was for rural farmers, was ...
Bush v. Gore...
The 2007-8 destabilization of Wall Street by what ought to have been an easily-handled amount of bad subprime mortgages...
The failure in 2008-9 to follow the Bagehot rule--to lend freely on collateral that was good in normal times, but at a penalty rate...
The failure of North Atlantic central banks to stabilize nominal GDP after 2009...
In all six I was betrayed by my knowledge—the thin-tails disease. I thought I understood a situation that I knew a lot about. I did not reflect that, as Robert Solow semi-quotes Damon Runyon: “Between human beings nothing is more than three-to-one.”
I have concluded that to say that these are “black swans” is to fundamentally mistake the problem—they happen far too often.
It is, rather, Dunning-Kruger—the belief that since you know about this, you got this, and other people will also know what you know and behave as you think you would behave.
Regarding Taleb and homeopathy:
Here is an interesting science article that gives one pause. Although Taleb invokes the placebo effect (a 20% absolute clinical effect, as opposed to our best drugs having a 5% absolute effect), there may actually be something worth seeing.
https://arxiv.org/pdf/1012.5166.pdf
This is a paper making a sensational claim. The first author is Luc Montaganier, who is the Nobel Laureate for isolating the HIV virus. In the paper he demonstrates that certain pathogens have an electromagnetic signature that can be embedded into water. From here, the pathogen’s DNA code can be realized and isolated through laboratory techniques. Additionally, that same water may be cultured by human lymphocytes to recover the intact pathogen, with the full understanding that a living cell is a complete PCR lab as well as the necessary substrate for culturing pathogens. This largely speaks to the pleiomorphic properties of water. There may be something regarding homeopathy and naturopathy.
Black-swans-that-aren't are a dime a dozen in financial markets.
In the 1987 stock market crash, I was informed (but did not reliably verify) that there were people forced out of long put positions because the rise in implied volatility caused their Initial Margin to increase by more than the improved moneyness of their positions caused their Variation Margin to decrease.
ETA: to spell out my point, if the young quant whippersnappers in your vignette had said "we think that this 'portfolio insurance' is going to blow up and cause the market to crash, let's put on a leveraged short position with options", the wise old market hands would have asked "OK, what would be the implication for margin calls in that scenario?"