Archive for September 18th, 2008

Great piece from Black Swan author,Nassim Nicholas Taleeb, on Edge.org.

Read it.

What Is Fundamentally Different About Real Life

My anger with “empirical” claims in risk management does not come from research. It comes from spending twenty tense (but entertaining) years taking risky decisions in the real world managing portfolios of complex derivatives, with payoffs that depend on higher order statistical properties —and you quickly realize that a certain class of relationships that “look good” in research papers almost never replicate in real life (in spite of the papers making some claims with a “p” close to infallible). But that is not the main problem with research.

For us the world is vastly simpler in some sense than the academy, vastly more complicated in another. So the central lesson from decision-making (as opposed to working with data on a computer or bickering about logical constructions) is the following: it is the exposure (or payoff) that creates the complexity —and the opportunities and dangers— not so much the knowledge ( i.e., statistical distribution, model representation, etc.). In some situations, you can be extremely wrong and be fine, in others you can be slightly wrong and explode. If you are leveraged, errors blow you up; if you are not, you can enjoy life.

So knowledge (i.e., if some statement is “true” or “false”) matters little, very little in many situations. In the real world, there are very few situations where what you do and your belief if some statement is true or false naively map into each other. Some decisions require vastly more caution than others—or highly more drastic confidence intervals. For instance you do not “need evidence” that the water is poisonous to not drink from it. You do not need “evidence” that a gun is loaded to avoid playing Russian roulette, or evidence that a thief a on the lookout to lock your door. You need evidence of safety—not evidence of lack of safety— a central asymmetry that affects us with rare events. This asymmetry in skepticism makes it easy to draw a map of danger spots.

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