Nassim Nicholas Taleb

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daryll40
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Nassim Nicholas Taleb

Post by daryll40 »

Any DIEHARDS study this guy? Someone on one of these forums suggested I research him. Fascinating.

Basically he bets on the unexpected and says that too much of life is falsely based on belief in the ability to predict the future as based on the past. Not far from Diehard thinking.

I am posting this because I don't totally understand it/him and would bet that some folks here smarter than me :oops: can better explain. :wink:
Warner
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The Black Swan

Post by Warner »

I'm reading his new book - "The Black Swan: The Impact of the Highly Improbable"

Taleb has a web site, but a good place to start is Malcolm Gladwell's 2002 New Yorker profile, "Blowing Up" - http://www.gladwell.com/2002/2002_04_29_a_blowingup.htm

"Taleb likes to quote David Hume: "No amount of observations of white swans can allow the inference that all swans are white, but the observation of a single black swan is sufficient to refute that conclusion." Because L.T.C.M. had never seen a black swan in Russia, it thought no Russian black swans existed. Taleb, by contrast, has constructed a trading philosophy predicated entirely on the existence of black swans. on the possibility of some random, unexpected event sweeping the markets."

The men at the table were in a business that was formally about mathematics but was really about epistemology, because to sell or to buy an option requires each party to confront the question of what it is he truly knows. Taleb buys options because he is certain that, at root, he knows nothing, or, more precisely, that other people believe they know more than they do.
johndcraig

Post by johndcraig »

I’d say it’s a long way from Diehard thinking

Diehard thinking says the past explains the future, but you don’t know when or how those past events might repeat themselves. Taleb says that things may happen in the future that have never been seen in the past.

Most agree that the market does not follow a normal bell curve. For a good discussion of this see, http://www.indexfunds.com/articles/20030808_Risk.htm. This Swedroe article explains how non normal markets behave. If you are interested in this stuff, you might also read Mandelbrot, The (Mis)behavior of the Markets. His bottom line is that most people underestimate the downside risk in the market.

The message is don’t be lulled into thinking that we understand the limits of bad markets simply by looking at the past. The market future is not limited to some variations of the past.

John
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Post by White Coat Investor »

I think he has some ideas that are important for all diehards to be familiar with, whether they agree with them or not.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course
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Post by richard »

His book Fooled by Randomness is well worth reading (and was discussed extensively on M*). A basic premise is not to confuse random luck with talent. He is more than a bit arrogant, but very entertaining.

I don't believe diehard thinking says the past explains the future. Past performance may well be irrelevant to future results.
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oneleaf
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Re: The Black Swan

Post by oneleaf »

Warner wrote:I'm reading his new book - "The Black Swan: The Impact of the Highly Improbable"
[/i]
How do you like it so far? I loved Fooled by Randomness.
TimDex
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Fascinating books

Post by TimDex »

Both of Taleb's books are worth reading. (Fooled by Randomness and Black Swan.)

His thinking could be said to intersect with DH thinking in a lot of ways; I would say he comes down on the side of markets being efficient except when you really need them to...

His own investments are a combination of 80-90% short term treasury bills and the remainder put into a wide variety of long-shot "random" bets. I assume private equity, options, derivatives, venture equity and the like.

I like his books, and I think they are a good corrective to anyone who's thinking that investment returns will mirror past historical returns. But I think his investment style is way outside of what I'm comfortable with. Myself, I'll go with an index-modified Ben Graham style, a modest stock-bond ratio with as much diversification as I can, and leave it at that.

Tim
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Post by larryswedroe »

I highly recommend his book, lots of wisdom in there
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Re: The Black Swan

Post by TravisMorien »

Warner wrote:I'm reading his new book - "The Black Swan: The Impact of the Highly Improbable"
I always grin when people talk about "black swans" as improbable events.

Swans in the Southern Hemisphere are black, and far from improbable they're very common in the rivers and lakes of Australia.

http://en.wikipedia.org/wiki/Black_swan
http://www.australianfauna.com/blackswan.php

Travis
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Post by tnlsea »

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Re: The Black Swan

Post by Bylo Selhi »

TravisMorien wrote:Swans in the Southern Hemisphere are black, and far from improbable they're very common in the rivers and lakes of Australia.
And the "white" in Great White North isn't intended to describe the colour of our swans ;) This fellow lives in a park a few miles to the west of me.

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Post by DRiP Guy »

johndcraig wrote:I’d say it’s a long way from Diehard thinking

Diehard thinking says the past explains the future, but you don’t know when or how those past events might repeat themselves.
1. I know you and I are beginning to seem destined to not ever be on the same side of any issue, but please don't take this response as just mindlessly playing into that role. I am speaking from my carefully considered opinion.

2. I t is possible as a relative newbie, I really don't grok Diehard or Boglehead philosophy, but I would hazard that you are incorrect here. I don't know that Jack Bogle himself, nor any of his adherents, have ever said that the past explains the future. Nor that it even predicts it particularly well unless you are looking at very large periods of time. I think they mostly consider that the past is simply our best [albeit still poor] indicator we usually have access to, even though most who say that also immediately acknowledge 'but there is no guarantee that the future will be precisely like whatever came before."

3. I would find it most helpful if in future you ascribe some generic character to an entire class of people or even a specific individual, you would also at least provide the courtesy of linking to a reference or example to support your contention.

Cheers.
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Murray Boyd
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Taleb is terrific

Post by Murray Boyd »

I love Taleb. He's a hoot. I loved "Fooled by Randomness." It'll rub a lot of folks the wrong way, but that's part of the fun. You have to keep in mind that his audience is hedge fundies that think they have the whole world figured out. That's the source of his contempt.

That Gladwell article captures about 50% of the value of the book, so I'd only recommend the book if you loved the article.

I actually find a lot in common with Taleb's view of the world and folks like Bogle and even our own Taylor (even if Taylor has all of the courtesy Taleb lacks). After having seen and done just about everything, wising up to the BS in the financial industry, you throw your hands up in the air and say, "I don't know and I don't care." What you're left with is save money, keep costs low, and watch out for taxes.
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Post by AzRunner »

I also recommend Taleb's Fooled by Randomness and Mandelbrot's The (Mis)behavior of the Markets. Both provide perspective on the bad things that can happen in markets. Does Taleb's Black Swan provide any additional insight over Fooled by Randomness?

As far as how I translate this into my own investment portfolio; I think I tend to be more conservative realizing that really bad market behavior can happen. However I still follow a basic widely diversified portfolio vs. the kind of portfolio that Taleb follows in Fooled By Randomness.

My impression of johndcraig's view of Diehards is that he views their general thinking as being overly complacent about market risk. Of course this is a generalization but IMHO he has it about right. OTOH risk tolerance is a personal decision and the individual investor lives with the consequences. That's why Taleb and Mandelbrot are worthwhile. They articulate some of these bad things and provide some rigor behind their arguments.

Norm
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Taleb

Post by nick22 »

I had the good fortune of reading Peter Bernstein's Against the Gods (the evolution of the concept of risk) and Taleb's Fooled by Randomness (do not treat the improbable as impossible) back to back. They provided a very nice primer on the concept of risk. (notice my black swan Avatar.

Taleb's two main points I took away were "do not treat the improbable as impossible" (which is what Larry always reminds us) and do not confuse a good ex-post outcome with a good ex-ante strategy. The latter refers to the fact that people can be very successful for periods of time by not controlling rare risk events that can have severe consequenses, and do not applaud the strategy of these fools. Though our society is very outcomes focused, and we often reward and praise the lucky individuals who suceed in this fashion, even though they may implode in the near future because they didn't control for improbable but severe risks.

I think these concepts are important for the individual investor:

1. Manage your investment risk and don't become consumed with recency bias to ignore risks that may surface (hyperinflation, EM crash, disability, etc.). Human beings have a tendency towards ignoring the improbable events, even if these events may bankrupt them.

2. Do not confuse an investor with better returns for an investor with a better strategy. Way too many investors and even posters on this board look at returns as the holy grail for justifying a strategy and AA. Higher returns may reflect the inappropriate risk management startegy of a lucky individual (like the guy in the office next to you who is cashing out of his 30% EM and 30% commodity portfolio).
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Murray Boyd
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Post by Murray Boyd »

"Against the Gods" and "Fooled by Randomness" together are an interesting combo. By the end of "Against the Gods" Bernstein's declared victory over risk. Then Taleb comes along and knocks the financial engineers off their pedestals.

The first 3/4 of "Against the Gods" is really great though.
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Post by yobria »

Keep in mind Taleb lives in the risky leveraged hedge fund world, where a single black swan can bankrupt you (eg Long Term Capital Management). Taleb's teachings aren't as relevant to us diversified low risk investors IMO. Still FBR is a fun book to read, if you can get past the ego.

Nick
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Black Knights
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Process versus Outcome

Post by Black Knights »

Further to nick22's comments above:

From Michael J. Mauboussin's More Than You Know: Finding Financial Wisdom in Unconventional Places:

Code: Select all


                                                                     Outcome

   
                                                       Good                              Bad



                             Good                   Deserved Success                 Bad Break

Process Used to
   Make the Decision


                             Bad                    Dumb Luck                        Poetic Justice

Jed
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Watch out for a visit from the black Swan

Post by Gordon »

Indirectly both Ferri and Swedroe warn investors to build very conservative portfolios when you have accumulated enough money in your investment accounts. When you have enough marketable securities it is time to keep your equity allocation in the 20% to 30% range. The added wealth you could have earned with a more aggressive portfolio is not sufficient to make up for a visit from the black swan.
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craigr
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Great book...

Post by craigr »

I haven't read his latest book. Fooled by Randomness is a great read though. Taleb reinforces the idea of "fat tail" events in the market. His perspective is a great one to read if you think a high-equity portfolio (even diversified across multiple assets) is a good idea and will protect you.

Another great book to read along the same lines is "A Mathematician Plays the Stock Market". He discusses many important concepts relating to risks and markets in a non-mathematical way. He intertwines the book with funny accounts of how he lost lots of money buying Worldcom and ignoring his own advice...
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Re: Watch out for a visit from the black Swan

Post by Paul Douglas Boyer »

Gordon wrote:When you have enough marketable securities it is time to keep your equity allocation in the 20% to 30% range. The added wealth you could have earned with a more aggressive portfolio is not sufficient to make up for a visit from the black swan.
Should Warren Buffet invest in a Target Retirement 2005 Fund? Bill Gates?
I think we need to qualify what is meant by "when you have enough." Perhaps what is meant is "when you get to where you have just enough." But some folks have "more than enough" and wouldn't they be able to take on more risk?
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Post by larryswedroe »

Paul
The great irony in life is that the very people who have the most ability to take risk (the very wealthy) have little need to take risk---their marginal utility of wealth is very low
This is IMO the main answer to the "equity risk premium puzzle"---why the ERP has been so high: It has to be high to get the high net worth people to take risks.

I know many very high net worth people who are 100% bonds and some that are believe it or not 100% treasuries. Any extra return to them is not worth the risks, no matter how small. Others feel the other way. Once they have sufficient funds in safe investments then any amount above that can go to risky equities.

There is obviously no right answer---just one right for each person. I personaly fall closer to the first category than the second.
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Post by matt »

Travis,
For a long time, Europeans believed that all swans were white, since they had never seen disconfirming evidence. The Wikipedia link you provided says that black swans were "discovered" in 1697 in Australia (obviously from the European perspective; I expect indigenous Australians were a bit less surprised by the revelation). I live in the northern U.S. and have still never seen a black swan. For all I know, those photos are doctored :)

Taleb's argument is that this type of thinking, in that most people don't believe something can be or can happen if they haven't seen it before, is what he bases his investment strategy on. Not how I roll, but I do like to play the contrarian.
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Black Swans

Post by pkcrafter »

Travis Wrote:
Swans in the Southern Hemisphere are black, and far from improbable they're very common in the rivers and lakes of Australia.


Yes, but do they have fat tails?

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
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Didn't like Taleb

Post by Gordon »

I did not enjoy reading Taleb's book. He gave too many examples that were not very clear as to what he was driving at or how the example related to his message. In a half dozen paragraphs Larry could condense all Taleb has to say.

I can think of hundreds of real life examples that he could have sharred with us and so could Rick. But this type of information is never found in books by those who have worked in the brokerage , market making or the speculative trading environment.

I have a dozen books or so on the careers of brokers and traders and have talked with an equal number of them in person over the years with disapointing results.
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Post by laurenjf »

There is a new and interesting podcast interview with Nassim Taleb on the ideas in his books at EconTalk:

http://www.econtalk.org/archives/2007/0 ... black.html

EconTalk's host, Russ Roberts, also recently intereviewed John Bogle:

http://www.econtalk.org/archives/2007/0 ... nvest.html
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Post by rich »

I have yet to read either book but it is definitely now on my list. This guy is fascinating. I think that few diehards would go to Taleb extremes but he certainly supports arguments for having extremely diversified portfolios with a good representation of risk free investments (treasuries).

Here is a link to his website which includes links to book reviews and some audio interviews.

http://www.fooledbyrandomness.com/

Best,
Rich
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Murray Boyd
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Post by Murray Boyd »

I'm about 100 pages in to The Black Swan and I hate to say that it's pretty repetitive. I'm not sure what's in it that wasn't in his first book or in Mandelbrot's book.
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this guy really has me thinking

Post by rich »

So if the extremely safe end of the spectrum is heavy investment in United States treasuries then what would constitute the small percentage of investments at the extremely risky end?

Does Taleb lend support to the people that devote 5% of their portfolio to “play” or “mad” money? Is Andrew Tobias’s site, which has largely turned into a place for stock tips for people with money “they can truly afford to lose”, actually on the right track? How about a 50% US Treasury and 50% emerging market portfolio?

Thanks!

Best,
Rich
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Re: The Black Swan

Post by AzRunner »

Warner wrote:Taleb has a web site, but a good place to start is Malcolm Gladwell's 2002 New Yorker profile, "Blowing Up" - http://www.gladwell.com/2002/2002_04_29_a_blowingup.htm
This is a great recap article of Taleb's approach.

It would seem that some Diehards might want to invest a small amount of money in these out of the money options based on Larry Swedroe's admonition that the unlikely is not impossible. But, how to choose which ones to buy? It seems that an implemented computer model is required. I do not see any information about Taleb himself looking for investors.

Do any Diehards invest in any of these long shot investments? The only thing I have are some gold and silver coins.

Norm
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Murray Boyd
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Taleb and asset allocation

Post by Murray Boyd »

Taleb has 80% in bills and the rest in his own hedge fund, which buys options in extremely unlikely price fluctuations. And no, you can't invest in his fund. He prefers banks and insurers as his clients.

Taleb doesn't exactly give asset allocation advice, but he mentions something about how a person could be mostly in bills and the rest in fat-tails type business. He specifically mentions venture capital, biotech, and book publishing. They have to be things with the opportunity of colossal payoff -- the next Google or Microsoft -- and not things with an upper limit, like a gas station.

I think I'll stick to our way.
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Post by ataloss »

black swans by NN Taleb
The metaphor of the Black Swan is historically
attributed to the difficulty in inductive logic called
Hume’s Problem of Induction...and of the complications that
lie in deriving general rules from observed facts –and
from those facts only. How many white swans does one
need to observe before inferring that all swans are
white and that there are no black swans? Hundreds?
Thousands? The problem is that we do not know where
to start –we lack a framework of analysis to know if our
ex ante estimation is appropriate, which is key in any
form of inductive inference. Note that the Black Swan is
not just a metaphor: until the discovery of Australia
common belief held that all swans were white; such
belief was shattered with the sighting of the first
cygnus atratus.

http://www.fooledbyrandomness.com/ARTE.pdf

I liked the Gladwell article. I though the explanation of Taleb's tradiing was better than Taleb's.

I hope I am not required to believe johncraig's version of Diehard thinking to post here.
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Murray Boyd
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Post by Murray Boyd »

larryswedroe wrote:I know many very high net worth people who are 100% bonds and some that are believe it or not 100% treasuries.
I read a long time ago that Steven Spielberg is almost in 100% in bonds, like a billion dollars worth.
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United
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Post by United »

His fund basically went out of business since he wrote Fooled by Randomness.
ataloss
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Post by ataloss »

His fund basically went out of business since he wrote Fooled by Randomness.
did it blow up? I'd be interested in reading about it if you have a link.
johndcraig

Post by johndcraig »

Dripguy

Sorry for the late response.

You took issue with my comment,
Diehard thinking says the past explains the future, but you don’t know when or how those past events might repeat themselves
Needless to say, I was generalizing, but I think it is a valid generalization. Note that I said “you don’t know when or how those past events might repeat themselves”. The great majority on this forum look to the past to determine how much they expect equities to outperform fixed and what period of time is needed to virtually assure outperformance. Maximum expected market downside is almost always by reference to historical downturns. TrevH has become very popular with his historical analyses of asset class performance. Etc.

Taleb’s and Mandelbrot’s view is that most people underestimate market risk because they do not take into account black swans (or monsters lurking in the fat left tail). I think that view does describe the great majority (not all) of diehards.

John
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Teetlebaum
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Confirmation bias?

Post by Teetlebaum »

I'm glad to see this discussion, since I'd heard of him but I'm not up to wading through his books.
TimDex wrote:His own investments are a combination of 80-90% short term treasury bills and the remainder put into a wide variety of long-shot "random" bets. I assume private equity, options, derivatives, venture equity and the like.
Murray Boyd wrote:Taleb doesn't exactly give asset allocation advice, but he mentions something about how a person could be mostly in bills and the rest in fat-tails type business. He specifically mentions venture capital, biotech, and book publishing. They have to be things with the opportunity of colossal payoff -- the next Google or Microsoft -- and not things with an upper limit, like a gas station.
Any of that seems awfully complicated for an individual investor. It's so much easier to be fairly passive after choosing a number of index funds. Is that what they call confirmation bias?
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Re: Confirmation bias?

Post by AzRunner »

Teetlebaum wrote:Any of that seems awfully complicated for an individual investor. It's so much easier to be fairly passive after choosing a number of index funds. Is that what they call confirmation bias?
My understanding of confirmation bias is that you tend to read and accept ideas that agree with your own thinking while rejecting ideas that are contrary to your thoughts.

Thus as an indexer I am generally happy to read articles by Jonathan Clements, Rick Ferri, Larry Swedroe and William Bernstein since they generally confirm what I already believe to be true. It also buttresses my defense against the vast majority that thinks that actively managed funds or individual stocks are the way to go.

Norm
johndcraig

Post by johndcraig »

My takeaway from Taleb (but more so from Mandelbrot)

Despite the fact that everyone is willing to give lip service to bad events happening, IMO few take to heart what Taleb and Mandelbrot are saying. Truly unexpected results that are far different and perhaps much worse than anything that has happened in the past are a real possibility. Normal bell curve rules don’t apply and 10 sigma events are possible. Mandelbrot deals with this in the context of fractal geometry for which he gives a layman’s definition.

For me, the takeaway from this is not to attempt to match Taleb’s investments. Passive investing is fine, but each should take heed when Mandelbrot says that most people’s thinking is locked into normal curve thinking and as a result they underestimate the actual risk that exists from the fat left tails.

In response to comments like mine many people call for a mathematical equation that will tell them precisely how to adjust one’s AA for these contingencies. Failing that, most ignore the warning. IMO it is wrong to ignore Taleb's and Mandelbrot's warnings and each should consider the possibility of making some adjustment to account for the real possibility of black swans; no precise formulas exist.

John
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Post by BrianTH »

Personally, I always hesitate to generalize about what the people posting here believe. Indeed, on many issues I don't think there is a majority for any particular view, but instead a wide spectrum of views.

And in my experience, at least, that is certainly true when it comes to something like the fat tails issue, and even more so of the even broader issue of how much we can learn about what to expect in the future from what has happened so far in the past. And even when people more or less agree on the nature of these problems, a whole new set of issues and possible disagreements arises when one asks what we can do to address these problems.

In other words, the practical side of this issue is hardly a dichotomy. But, of course, in order for us to even have a conversation about what we might do about these problems when making our investment decisions, we have to consider proposals with at least some minimal amount of specificity. Otherwise, we are not really discussing anything practical at all.
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Post by bob90245 »

johndcraig wrote:Truly unexpected results that are far different and perhaps much worse than anything that has happened in the past are a real possibility.

...

Passive investing is fine, but each should take heed when Mandelbrot says that most people’s thinking is locked into normal curve thinking and as a result they underestimate the actual risk that exists from the fat left tails.

In response to comments like mine many people call for a mathematical equation that will tell them precisely how to adjust one’s AA for these contingencies. Failing that, most ignore the warning. IMO it is wrong to ignore Taleb's and Mandelbrot's warnings and each should consider the possibility of making some adjustment to account for the real possibility of black swans; no precise formulas exist.
Someone once said that US stock returns have been the result of luck. Not sure if it was good luck or Bad Luck. I guess what you're saying, John, is that investors should be prepared for the worst. Something like Japan in the 1990's or the UK in the 1970's. Or even worse.

If I had that bunker mentality that the Sky is Falling, I guess I might only own gold.
johndcraig

Post by johndcraig »

Brian, re specificity
But, of course, in order for us to even have a conversation about what we might do about these problems when making our investment decisions, we have to consider proposals with at least some minimal amount of specificity. Otherwise, we are not really discussing anything practical at all.
I’m not sure exactly what you are getting at, but you seem to be saying that without a specific plan, there is no plan at all. If that is what you are saying, then I disagree.

To me a nonspecific plan is better than no plan at all. If one agrees that he/she has not been considering black swans, then that person should factor some increased level of conservatism into all of those factors that go into setting her AAs. For example, if she considers need-ability-willingness in the context of her financial situation and age, and that has been done without considering black swans, then the AA should be reconsidered by adding the black swans. No mathematical formula exists; it is about using one’s best judgment. It is far from perfect, but doing something here is better than doing nothing.

John
BrianTH
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Post by BrianTH »

johndcraig wrote:To me a nonspecific plan is better than no plan at all. If one agrees that he/she has not been considering black swans, then that person should factor some increased level of conservatism into all of those factors that go into setting her AAs. For example, if she considers need-ability-willingness in the context of her financial situation and age, and that has been done without considering black swans, then the AA should be reconsidered by adding the black swans. No mathematical formula exists; it is about using one’s best judgment. It is far from perfect, but doing something here is better than doing nothing.
I don't want to repeat our prior debates on this subject. I'll just note that what you have said so far is fine in theory, but I also have no idea what you are actually proposing one should do in practice. You always object at this point that I want a mathematical formula or a "perfect" plan, but that is false. I would just want something more than "be more conservative" or "use your best judgment", because that is advice without content. But I understand that you either will not or cannot be more specific, so that is as far as our conversation can go.
johndcraig

Post by johndcraig »

BrianTH wrote:I would just want something more than "be more conservative" or "use your best judgment", because that is advice without content. But I understand that you either will not or cannot be more specific, so that is as far as our conversation can go.
You seem to be criticising me for not being able to quantify the black swans better than Taleb or Mandelbrot can. Is your conclusion that if they can't be better quantified then they don't exist? So what is your advice to someone who now believes that black swans create additional risk, but previously did not consider them in her allocations? Is your advice to do nothing? If so why?

John
HockeyMike35
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Post by HockeyMike35 »

John,
Despite the fact that everyone is willing to give lip service to bad events happening, IMO few take to heart what Taleb and Mandelbrot are saying. Truly unexpected results that are far different and perhaps much worse than anything that has happened in the past are a real possibility
I have seen no evidence of this. I do not think I have ever seen someone suggest that it is impossible for the future to be different from the past. Can you provide some quote's that support your assertion?
In response to comments like mine many people call for a mathematical equation that will tell them precisely how to adjust one’s AA for these contingencies.
Again, I see no evidence of this claim. Of course there is no precise mathematical equation to figure this out. Can you show an example of someone calling for one?

Good Luck,

Mike
BrianTH
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Post by BrianTH »

johndcraig wrote: You seem to be criticising me for not being able to quantify the black swans better than Taleb or Mandelbrot can.
Of course that is not what I am doing. And I see no reason why you would even think that was a plausible interpretation of what I was saying. As always, John, I think you should stick to speaking for yourself--when you start trying to characterize what others believe, I think you get into trouble.
Is your conclusion that if they can't be better quantified then they don't exist?
Again, of course not, and I would suggest the same thing: you are better off sticking to speaking for yourself and not trying to characterize others.

So what is your advice to someone who now believes that black swans create additional risk, but previously did not consider them in her allocations? Is your advice to do nothing? If so why?
Well, we have discussed many possible implications of the fat tails problem and some of its variations. One of the simplest implications is that I think these observations give people a reason to shift more of their fixed income to shorter terms, perhaps all the way to cash or cash-like assets (which for me is a broad category including TBills, stable value funds, the TSP G Fund, TIPS, and perhaps gold). They can then restore their desired expected volatility-adjusted returns by slightly increasing their equity percentages. I think the net effect of this shift to shorter term/cash-like assets helps address some notable aspects of the fat tails problem.

Another possible suggestion is to look at adding CCFs to the portfolio. In at least some fat tails scenarios, they can prove pretty useful in moderating losses, and plausibly they are likely to also have neutral or beneficial effects on the portfolio outside of fat tails scenarios.

On the broader issue of what I would call the structural breaks/info gap problem (the past not necessarily being a good guide of what to expect in the future)--I think the best advice is to follow what has been called a "know nothing" philosophy. Basically, the idea is that since we cannot be sure what strategies will work in the future, and with what probability, the best we can do is use a bit of all the plausible strategies and not overcommit to any one technique which has worked in the past.

Among other things, I think one implication of this philosophy is that one should not overcommit to using just financial assets (eg, stocks and bonds), but rather one should also include a healthy dose of real assets or their derivatives (eg, real estate or REITs, commodities or CCFS, and so on). I think it also makes ample sense to avoid overloading on country-specific risk, which is a particular concern for US investors.

So, those are a few ideas we have discussed.
ccbwc
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Guarding against the Black Swan

Post by ccbwc »

Couldn't you guard against the Black Swan by going long volatility. It seems like what he is saying is that people underestimate the likelihood of fat-tailed events. If a fat-tailed event occurred, the volatility (which is very low right now) would soar.

Still, you need to worry about the counterparty's capacity to honor the contract, but you would presumabaly have multiple contracts.
Regards,
Chip Plumb
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AzRunner
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Post by AzRunner »

johndcraig wrote:For me, the takeaway from this is not to attempt to match Taleb’s investments. Passive investing is fine, but each should take heed when Mandelbrot says that most people’s thinking is locked into normal curve thinking and as a result they underestimate the actual risk that exists from the fat left tails. John
I basically agree with this statement. If you take the general Vanguard risk test and it says 60/40 then you should probably scale this back based on your gut feel about bad things. By definition this bad thing would be significantly worse than October, 1987, the tech bubble bursting or 9/11, since these ultimately did not lead to any kind of catastrophic failure.

I think BrianTH has some good suggestions regarding how one can alter their portfolio based on the risk of fat tails. What I have done is increased my fixed income holdings and increased my holdings of TIPS as a % of my fixed income. Also, 50% of my fixed income is short-term.

Norm
ccbwc
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Random thoughts

Post by ccbwc »

These are just thoughts off the top of my head, so please take them as such.

It seems that people, in general, think it is very prudent to hedge against the risk of fat-tails in many parts of their life. Think, for example, of fire insurance.

But, with their portfolios, they view such insurance as too risky, because it almost always loses money (negative expected return). But so does fire insurance.

Right now, I think insurance (in the form of going long the VIX) is very cheap insurance against a portfolio fat-tail.

The reason I think it is cheap is due to the proliferation of hedge funds and private equity funds. The managers of these funds have an assymetric risk profile that is not aligned with the normal investor. Their pay structure is such that they get 20% of the profits if they win, but if they go bust, they don't have to give back those profits. In this situation, the profit maximizing strategy would be to seek out volatility. With so much money seeking volatility, those of us who want to sell volatility (buy insurance against fat-tails) should be able to do so at an attractive price.

Right now, Jeremy Grantham says everything is in a bubble. He might be right. If he is right, then it would seem that fat-tailed events are more likely than normal. But, if he is wrong, it seems like insuring against this possibility is paradoxically simultaneously cheap due to the proliferation of volatility seekers.

To some, this might seem like a wild speculation, but I'm starting to think that it is no more of a speculation than fire insurance.

If lots of people want volatility and I want to insure against it, it seems like I am in a strong bargaining position.

Regards,
Chip Plumb
rich
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Post by rich »

BrianTH wrote: Well, we have discussed many possible implications of the fat tails problem and some of its variations. One of the simplest implications is that I think these observations give people a reason to shift more of their fixed income to shorter terms, perhaps all the way to cash or cash-like assets (which for me is a broad category including TBills, stable value funds, the TSP G Fund, TIPS, and perhaps gold).
BrianTH wrote: Another possible suggestion is to look at adding CCFs to the portfolio. In at least some fat tails scenarios, they can prove pretty useful in moderating losses, and plausibly they are likely to also have neutral or beneficial effects on the portfolio outside of fat tails scenarios.
BrianTH wrote: Among other things, I think one implication of this philosophy is that one should not overcommit to using just financial assets (eg, stocks and bonds), but rather one should also include a healthy dose of real assets or their derivatives (eg, real estate or REITs, commodities or CCFS, and so on). I think it also makes ample sense to avoid overloading on country-specific risk, which is a particular concern for US investors.
Yes, yes, and yes! Taleb's approach can coexist peacefully and even integrate with the diehard philosophy.

Have an appropriate bond/fixed allocation and diversify!
Best regards, | Rich
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