Black Swans are the ultimate extreme risk events. Their occurrence, therefore, is supposed to be so rare as to almost never happen.
But in today's world of globalization and interconnectivity — their frequency belies their improbability. Where statistically they should be a 'once in a thousand years' event, they now seem to be always lurking just around the corner.
A definition is in order, as per Nassim Taleb.
— A Black Swan is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility.
Even when event is predicted to occur — sooner or later — the doubts and indifferences of markets — their ‘immediacy bias’ creates risk inertia — a lack of attention to such a potential threat.
COVID-19 is one such example, where no strategies or procedures ever addressed its probability — even after the precedent of SARS in 2003.
But because of the predictability of another SARS-like event, COVID-19 is really a ‘White Swan’ — not totally unexpected or unpredictable but extreme and devastating just the same.
When this outlier arrives, its impact is extreme and devastating.
The problem of risk is fundamental, and the deficiencies of its management are at the very foundation of probability — normal distribution — the ubiquitous bell curve and its one standard deviation capturing 68% of all risk. Or the equally dubious 'value at risk' (VaR) — covering losses under ‘normal’ market conditions.
But ‘normal’ is easy. And as such, it doesn’t mean anything. It’s the abnormal that gets you killed — from life, to relationships, to markets.
Taleb got it right when he called the normal distribution risk model ‘GIF’ — a Great Intellectual Fraud.
You already had a glimpse of it in 'A New Risk Engine'.
Efficiently structure protection under normal risk conditions — adequate hedge range, cost, and probability — so you can extend protection in conditions of extreme volatility.
So you have to get away from this concept of ‘normal risk’ and stop being overcharged for it.
