Tag Archives: Nassim taleb

Risk, Uncertainty and Black Swans: Theoretical Differences and Practical Implications

Every time Milo and I teach about how organizations can make sense of their environments, we are confronted with the difficulty of explaining why uncertainty is so different from risk and why understanding that difference matters to entrepreneurs and managers. In this article, we address those questions and discuss the practical implications that flow from them.

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Welcome to Extremistan! Why some things cannot be predicted and what that means for your strategy

In an earlier post about forecasting, I mentioned the work by Nassim Taleb on the concept of black swan. In his remarkable book, “The Black Swan”, Taleb describes at length the characteristics of environments that can be subject to black swans (unforeseeable, high-impact events).

When we make a forecast, we usually explicitly or implicitly base it on an assumption of continuity in a statistical series. For example, a company building its sales forecast for next year considers past sales, estimates a trend based on these sales, makes some adjustments based on current circumstances and then generates a sales forecast.  The hypothesis (or rather assumption, as it is rarely explicit) in this process is that each additional year is not fundamentally different from the previous years. In other words, the distribution of possible values for next year’s sales is Gaussian (or “normal”): the probability that sales are the same is very high; the probability of an extreme variation (doubling or dropping to zero) is very low. In fact, the higher the envisaged variation, the lower the probability that such variation will occur.  As a result, it is reasonable to discard extreme values in the forecasts:  no marketing director is working on an assumption of sales dropping to zero.

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We have met the enemy and he is, er, forecasting

There is no doubt we are terribly bad at forecasting. Even the smartest among us are. Even the best and the brightest, whom we have tasked to save the world from financial annihilation, are.  Take Ben Bernanke, Chairman of the Federal Reserve. In 2004, he declared, in a speech ominously titled “The Great Moderation”: “One of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility. This […] makes me optimistic for the future.” You might want to read the full transcript of the “Great Moderation” talk here because it is for a fascinating reading on how wrong experts can be at forecasting. And it’s not just Ben. In fact, political, economic and business histories are littered by forecasts and predictions that turned out to be ridiculously wrong. From the commercial potential of the Xerox machine or of Nespresso, from the possibility of heavier than air flight to the market for mobile phones, from prosperity at the corner of the street to Japan as number One. Our hopelessness at forecasting is a confirmed fact.

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