The famous “Black Swan” chart update from Soc Gen – or just a paradox?

Humans have a tendency to try and take things in our control. Call it control illusion. Expertise in a field is often confused with the ability to control. In order to control, we need to know in advance what is likely to happen. This prior knowledge can then be used to either change the outcome or profit from the same. The reality is far from it.

This is what I wrote in the book, “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”:

Experts also try to take full control of the situation. In order to do so, they try to get an exact estimate of the risks involved. Now, this is a quite counter-intuitive. Risk is uncertainty. How can one expect to be certain about uncertainty? Nassim Nicholas Taleb introduced the concept of “Black Swan”. He said, “Just because you have not seen a black swan, does not mean it does not exist. It just means that you have not seen one. And that is a big risk – the “unknown unknown”.

At one point, someone went really overboard to take charge of the situation. He asked his team, “Let us try and figure out which black swan events are possible in the near future.”

Spending time to identify a “black swan” in advance is futile. By definition, the moment you know a potential risk, it ceases to be a black swan.

And then we came across the following article on the website

the article refers to a famous chart by Societe Generale, in which they are not only trying to identify the black swans in advance, but they have also assigned probability as well as the potential impact of these black swans.

They are trying to take the control of the situation – identifying the black swans and even measuring the impact and probability of the same.

Wikipedia defines “black swan events” as under:

The black swan theory or theory of black swan events is a metaphor that describes an event that comes as a surprise, has a major effect, and is often inappropriately rationalized after the fact with the benefit of hindsight.

The definition is clear. It comes as a surprise. If you already know what is likely to happen and you know how big the impact is likely to be, is it a black swan event? In the report Soc Gen explains their interpretation of the term: Black Swan events are those which are unlikely to occur, but should they come about, would cause chaos on global markets.

Quite a different definition compared to that of Wikipedia. Seen in this context, they are talking about an unlikely event and not an unknowable. However, look at the contradiction: In one case the probability has been put at 40%. How can the probability of an unlikely event be so high as 40%? Is it not too high for an “unlikely” event? Paradoxical, to say the least.

#RidingTheRollerCoaster – 169


Leave a Reply

Please log in using one of these methods to post your comment: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s