In the financial world, everyone loves to talk about “potential Black Swan events.”
Societe Generale even releases a quarterly chart of “Black Swan” risks.
The concept of a “Black Swan” event takes its name from Nassim Taleb’s 2007 book “The Black Swan.” But there’s a slight problem: acknowledging an event’s possibility means it can’t be a Black Swan.
To wit, SocGen’s most recent Swan chart says that further deterioration in the economic situation in Europe poses a risk to the market. And like, objectively, a European economy that performs poorly is bad for the market. But this also isn’t a Black Swan. Or, can’t be a Black Swan.
A Black Swan is an event or occurrence — a tail event, as Taleb would call it — that is so remote that it is completely unforeseen.
(In fairness, SocGen doesn’t call these “potential Black Swans,” simply calling this their “Swan Chart,” but the “potential” phrase gets thrown around a lot, and a chart with pictures of black swans makes pretty clear what the firm is intimating.)
The famous example Taleb uses in his book is the Thanksgiving turkey.
“Consider a turkey that is fed every day,” Taleb writes. “Every single feeding will firm up the bird’s belief that it is the general rule of life to be fed every day by friendly members of the human race ‘looking out for its best interests,’ as a politician would say.
“On the afternoon of the Wednesday before Thanksgiving, something unexpected will happen to the turkey. It will incur a revision of belief.”
Here’s Taleb’s famous chart.
This is basically the book’s entire message wrapped up in one graphic.
The problem that Taleb is really attacking in his book is forecasting, particularly economic forecasting, and the practice of using past events to predict the future.
Using inductive reasoning to forecast future events poses, for Taleb, not just something potentially useless or wrong, but something that actually has negative value.
“Consider that [the turkey’s] feeling of safety reached its maximum when the risk was at the highest!” Taleb writes.
“But the problem is even more general than that; it strikes at the nature of empirical knowledge itself. Something has worked in the past, until — well, it unexpectedly no longer does, and what we have learned from the past turns out to be at best irrelevant or false, at worst viciously misleading.”
And this is really what the problem of Black Swans is all about.
It isn’t that we can’t know the future, but that we delude ourselves into thinking we can, making forecasts about events that are inherently unforecastable and giving us false belief about what can or will or might happen in the future.
When a Black Swan event really occurs, it will seem outside what had previously seemed possible. But Taleb would likely argue that this event only seems outside previous beliefs about what was possible because of how we arrived at those possibilities.
Namely, by using the past to forecast the future.
Just something to keep in mind as you sit down to enjoy your turkey on Thursday.
Or perhaps this will serve as fodder for light conversation with distant relatives this weekend.
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