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Tuesday, May 13, 2014

Book Analysis: “The Fat Tail: The Power of Political Knowledge For Strategic Investing”. By Ian Bremmer and Preston Keat Oxford University Press March 6, 2009

The idea of a “fat tail” originated with Harvard University Faculty of Arts and Sciences Department of Economics Littauer Center Paul M. Warburg Professor of Economics, and Stanford University Hoover Institution on War, Revolution, and Peace Senior Fellow, Robert Barro.
In his February 5, 2009 New York Times article “Fat Tail”, Pulitzer Prize winning Washington-based syndicated political columnist William Safire credits New York University Polytechnic School of Engineering Research Center for Risk Engineering Distinguished Professor of Risk Engineering Nasim Taleb with popularizing the term [12].
Taleb first predicted the notion of fat tails in his 1996 book “Dynamic Hedging: Managing Vanilla And Exotic Options”, and then in a December 1997 interview with The Economist Managing Editor Joe Kolman [8].
Safire describes that in a probability distribution in which the majority of events occur in the middle of the distribution, there is an “unexpectedly thick” end or tail toward the “ends of a distribution curves”, indicating an irregularly high likelihood of catastrophic events [12].
“Fat tails don’t mean more variance; just different variance.” Taleb writes in Volume 1 Section 9.3 of his January 2014 textbook “Silent Risk: Lectures On Fat Tails, Antifragility, Precaution, and Asymmetric Exposures: In which is Provided a Mathematical Parallel Version of the author’s 2013 “Probability and Risk In The Real World”, with Derivation, Examples, Graphs, Theorems, and Heuristics, with the Aim of Offering a Non-BS Approach to Risk and Probability under the Euphemism “The Real World” . “For a given variance, a higher chance of extreme deviations implies a lower chance of medium ones. ” [10]
JP Morgan Vice President Leslie Lammers explains: “You can look at…a graph of  “normal” probability distribution, or the “bell curve”, as it is known…as a representation of the probability of  finding a data point in a certain place—or in broader terms for this discussion, an event occurring… Instead of tapering off, our bell curve unexpectedly swells at one of its tails…when we have an unexpectedly high occurrence of what we thought were—or what should have been—statistically improbable events.” [9]
In his review of New York University global research Professor Ian Bremmer’s March 6, 2009 book, “The Fat Tail: The Power of Political Knowledge for Strategic Investing”, for Forbes, lawyer and author Gordon Chang writes that: “The Title of the work, of course, refers to statistically improbable events, which are plotted at either end—known as a “tail—of a bell curve. When these freak incidents occur, the normally thin tails bulge, or, in the parlance of today, they become “fat.” [4]
“Briefly, a fat tail is the fatter than expected tail end of a distribution of occurrences that are presumed to be random and therefore thin.” Bremmer writes for The Washington Post in a Wednesday March 25, 2009 interview. “When major risk events happen with much greater frequency than expected, you have a fat tail.” [2]
In “Silent Risk: Probability and Risk in the Real World”, Taleb lists the three causes of fat tails as “Randomness at the level of the scale of distribution”, “model error in all its forms”, and “Convexity of probability measures to uncertainty” [15]. 
In Chapter 1: “Introduction” of “The Fat Tail”, Bremmer notes that “storm of the century” events that appear unlikely to occur but are earth moving when they do “represent the risk that a particular event will occur that appears so catastrophically damaging, unlikely to happen, and difficult to predict, that many of us choose to simply ignore it.” In Chapter One of “The Fat Tail”, he addresses this:  “Too many corporations and organizations ignore political risk until it’s too late. These risks are either assumed to occur rarely or to someone else or to be entirely unpredictable.” [1]
“Basic human psychology prompts us to ignore outliers, even if they dwarf all else. Averages are easy to grasp.” Write Columbia University Scholl of International and Public Affairs Adjunct Professor of International and Public Affairs and Harvard Kennedy School research Associate Gernot Wagner and Harvard University Faculty of arts and Sciences Department of Economics Professor of Economic Martin Weitzman. “Outliers are in a league of their own…Humans are bound to brush aside such possibilities.” [16]
“We are hard-wired to find order in randomness, to turn scattered points into a coherent narrative, and to expect identified patterns to last forever. We become emboldened by our successes, and we think that we achieved control or at least can see what is coming next…….Too many of us are caught up in routine, or a “status quo bias”, as it is labeled by economists and psychologists.” George Mason University College of Humanities and Social Sciences and Center for Study of Public Choice Holbert C. Harris Professor of Economics, and Chairman and General Director of the George Mason University Mercatus Center, Tyler Cowen writes in his review of Taleb’s April 17, 2007 book “The Black Swan: The Impact of the Highly Improbable” for Slate. “The search for patterns can be a dangerous trap, distracting us from the impact of the highly improbable…It is disquieting to think we might be making bad choices, so we close off options and we shut down self-critical reasoning, whether subconsciously or by active choice.” [5]
            “Yes, fat tails can be “catastrophically damaging”, and…they are also, by definition, “unlikely” and “difficult to predict.” Writes Chang. “Therefore, many of us ignore them until they actually happen. That, of course, is a mistake.” [4]
Lammers goes further: “In short, Fat tails are statistically unusual events…this year’s term for “black swans”…popularized…by Nassim Nicholas Taleb in his book of the same name.” [9] Lammers’ fellow JP Morgan Chase Senior Vice President Jane Kim explains: “The term black swan…derives from the ancient belief, once widespread in the West, that all swans are white—a notion that was proven false when European explorers discovered black swans in Australia.” [7] “Before the discovery of Australia, it was generally assumed that swans we always white.” Cowen elaborates. “Suddenly, black swans turned up, unsettling people’s expectations.” [5]  “The gist: Anything is possible.” Kim concludes. “In fact, big surprises are more common than people think.” [7]
In an interview with Hofstra University Distinguished Visiting Professor of Law and Columbia Law School Lecturer in Law Scott Horton in the March 25, 2009 Harper’s Magazine, Bremmer himself acknowledged that Taleb’s has book “a lot common” with his own book, “The Fat Tail”, saying: “Both books argue that these events occur more often than we think.” [6]
“Call them “black swans”, “unknown unknowns”, “fat tails”, or “10-foot women”. Whatever you call them, they’re bizarre events.” Write Wagner and Weitzman. “They shouldn’t happen. Usually they don’t happen, but every once in a while they do happen, and then their impact makes daily events mere noise.” [16]
 “We never see black swans coming, but when they do arrive, they profoundly shape our world.” Taleb writes. “In economic life and history more generally, just about everything of consequence comes from black swans; ordinary events have paltry effects in the long term.” [13]
“Another human failing stems from the nature of happiness. In the short run, people’s happiness is often shaped more by how many “positive events” occur in their day than by the arrival of one important piece of good news.” Cowen writes. “We therefore look, consciously or not, for small but repeated successes when we should be shooting for “one large win”. It’s easy to see why: Big payoffs come only rarely, and perhaps late in life; in the meantime, who wants to keep on feeling like a loser?” [5] “There are government entities and the economic entities that they own and influence that radically change who the winners and losers. So the one thing that we need to do is understand as a consequence of this changing world, how do we thing about who the winners and losers are?” Bremmer told Forbes Magazine journalist and editor Michel Maiello in a March 31, 2009 New York interview. “Because we probably can’t affect who the winners and losers are very well. But we want to bet with the winners.” [11]
“100-year floods happen far more than once a century.” Writes Bremmer in “A Fat Tail”. [1] In a March 16, 2009 interview with the Chicago-based “RealClearPolitics”, founded by Loyola University Maryland affiliate adjunct instructor John McIntyre, Bremmer explains: “A fat tail is the storm of the century that now seems to appear once every six months. It’s the low probability, high-impact risk that occurs more often than we think.” [3] “The concept of “The Fat Tail” itself is that we increasingly live in a world where these one-in-100-year storms actually seem to happen every 15 minutes.” Bremmer told Maiello “So, what you expect is a normal distribution with really severe consequences that happens only a tiny, tiny percentage of the time. All of a sudden, they’re happening a lot.” [11]
“A 1-in-100-year event is indeed rare, by definition. But it may well dwarf all else in impact.” Wagner and Weitzman write. “And by now we know that 1-in-100-year storms—the hallmark often used for infrastructure—may be showing up much more frequently.” [16]
In the Harper’s interview, Bremmer says of his and Taleb’s books: “We also agree that risk managers too often fail to include these kinds of events in their risk models. In some cases, the risk is considered too unlikely to occur to devote substantial time and money to studying it. In others, there’s simply a fatalistic attitude toward catastrophe.” [6] “But he move from that point into the notion that fat tails can’t actually be anticipated or effectively managed.” Bremmer tells The Washington Post. “Where the point of my book, “The Fat Tail”, is that these risks increasingly stem from political factors.” [2] “The purpose of this book is that increasingly, those fat tails or big risks that are out there that really can savage the global economy and our own personal pockets are about politics.” Bremmer told Maiello in Forbes. [11] In Harper’s, he elaborates to Horton that: “An increasing number of the fat tails now roiling markets around the world are driven by political factors.” “But the books disagree on a crucial issue.” He tells Harpers. “Preston Kent and I believe that a good number of these risks can be measured and managed.” [6]
In “RealClearPolitics”, Bremmer repeats: “These risks are not necessarily unpredictable or unknowable—though some are. But too many companies and investors think they don’t need to worry about “extreme” events or that, especially when it come to politics, it isn’t worth analyzing risks that don’t neatly fit into standard statistical models.” He says, of “The Fat Tail”: “The central idea of the book is that fat tail political risks have become increasingly important for government, companies, and investors—and that they’re both more predictable and more manageable than other sort of fat-tailed risks.” [3]
 “I’m saying that unlike the black swan, where they recognize that there are lots of fat tails that happen but say that you can never asses them, you’ll never know where they come from.” He tells Maiello of Forbes. “Increasingly, you can.” [11]
“In these times of heightened geopolitical risk, political knowledge has become a hard currency.” Adds Emory University board Trustee Mutar Kent. “The ability to keep an open mind while being both rigorous and creative is necessary in order to successfully mitigate political risks.” Bremmer writes in the conclusion: “Mitigating Political Risks In An Uncertain World” of “A Fat Tail”. “Balancing this combination of skills is, at the end of the day, as much art as science.” [1]
 “Even science itself has a hard time grappling with fat tails. The scientific process largely works through repetition, which by definition does not apply here.” Wagner and Weitzman write. “Still, science can help us model fat tail that reach far beyond human imagination. Statisticians and economists have discovered patterns confirming the existence of fat tails in everything from stock market returns to extreme weather events.” [16]
In Chapter 3: “Geopolitics” of “The Fat Tail”, Bremmer writes that: “Globalization, economic integration, trade and capital mobility, and the free exchange of ideas across borders have not rendered politics obsolete.” [1] “When our concept of “normal” must be stretched so far as to include unanticipated natural disasters, wars, government shakeups and scandals, and so on, then normal goes by the wayside.” Writes Lammers. “When we try to squeeze life underneath a bell curve, then fat tail events…surprise us.” [9] “Unlike economic risks, political risks also tend to be more heterogeneous: Their causes vary greatly.” Bremmer writes in Chapter 4: “Political Risk and Capital Markets” of “A Fat Tail”. “The way politics impacts economic assets can be equally varied, from a government imposing currency controls, to a mob rioting and burning down a business, to panic starting among traders.” [1]
International Institute for Strategic Studies trustee Bill Emmott agrees: “Economics produces cycles and even crises, but it is politics that has the power to turn crises into profound and lasting dramas.” He says of “The Fat Tail” that it: “Should be essential reading for anyone involved in international business even—perhaps especially—in places that seem politically stable.”
 “What at first might appear an irrational choice might not be. Those who assume that Presidents, Prime Ministers, and members of Parliament care more about sound economic policy than their political fortunes are doomed to the occasional surprise, because political leaders sometimes make market-moving even market-crashing economic decisions to satisfy their political needs.” Bremmer writes in Chapter 5: “Domestic Instability—Revolution, Civil War, State Failure” of  “The Fat Tail”. “War, terrorism, expropriation, violent changes of government, politically motivated lawmaking and civil strife are not going away. Government will continue to change both national and international regulatory regimes, often dramatically.” [1] “Political risks are usually about political decision makers. There are actions taken by political actors.” Bremmer tells Maiello. “Government state leaders who make decisions that have negative economic consequences that are rationally political. If you can understand what’s behind that political decision-making process, you can have a much better sense of what these big risks are.” [11]
“Virtually by definition, the bulk of what goes on is ordinary events determined by ordinary processes—mixed in, of course, with some extraordinary influences.” Cowen writes in a criticism of Taleb’s work and, by extension, Bremmer’s. “Elevating the importance of the extraordinary alone is more rhetorical posturing than insight.” [5]




1.     Bremmer, Ian and Keat, Preston . “The Fat Tail: The Power of Political Knowledge For Strategic Investing”. Oxford University Press. March 6, 2009. http://global.oup.com/academic/product/the-fat-tail-9780195328554;jsessionid=E2924AB7E860CBAFF645A650EBD9AA69?cc=us&lang=en&
2.     Bremmer, Ian. “Books: The Fat Tail”. The Washington Post. Wednesday March 25, 2009. http://www.washingtonpost.com/wp-dyn/content/discussion/2009/03/20/DI2009032002854.html
3.     Bremmer, Ian. “Political Risk, the Financial Crisis and Strategic Investing”. RealClearPolitics. March 16, 2009. http://www.realclearpolitics.com/articles/2009/03/political_risk_the_financial_c.html 
4.     Chang, Gordon. “How To Expect The Unexpected”. Forbes. March 3, 2009. http://www.forbes.com/2009/03/02/fat-tail-risk-opinions-book-review_ian_bremmer.html
5.     Cowen, Tyler. “Nobody Expects The Spanish Inquisition—Or Do They? A Look At Nassim Taleb’s The Black Swan”. Slate. June 13, 2007. http://www.slate.com/articles/arts/books/2007/06/nobody_expects_the_spanish_inquisitionor_do_they.single.html
6.     Horton, Scott. “Six questions for Ian Bremmer, Author of Fat Tail”. Harper’s Magazine. March 25, 2009. http://harpers.org/blog/2009/03/six-questions-for-ian-bremmer-author-of-_fat-tail_/
7.     Kim, Jane. “Preparing for the Next “Black Swan”. The Wall Street Journal. August 21, 2010. http://online.wsj.com/news/articles/SB10001424052748703791804575439562361453200
8.     Kolman, Joe. “The World According To Nassim Taleb”. Derivatives Strategy Magazine. December 1997. http://docs.finance.free.fr/Options/Dynamic_Hedging-Taleb.pdf
9.     Lammers, Leslie. “Are Fat Tails And Black Swans Related?” Riverstone Advisors. April 2012. http://riverstoneadvisors.com/wp-content/uploads/2012/04/What-is-a-Fat-Tail.pdf
10.  Lehe, Lewis and Powel, Victor. “Normal Vs. Fat-Tailed Distributions”. University of California—Berkeley Blum Center For Developing Economies. 2013. http://vudlab.com/fat-tails.html
11.  Maeiello, Michael. “Transcript: Ian Bremmer”. Forbes. March 31, 2009. http://www.forbes.com/2009/03/31/ian-bremmer-transcript-opinions-business-visionaries-g20.html
12.  Safire, William. “Fat Tail”. The New York Times. February 5, 2009. http://www.nytimes.com/2009/02/08/magazine/08wwln-safire-t.html
13.  Taleb, Nassim. “Learning to Love Volatility: In A World That Constantly Throws Big, Unexpected Events Our Way, We Must Learn To Benefit From Disorder, Writes Nassim Nicholas Taleb”. The Wall Street Journal. November 16, 2012. http://online.wsj.com/news/articles/SB10001424127887324735104578120953311383448
14.  Taleb, Nassim. “Probability and Risk In The Real World”. 2013. https://docs.google.com/file/d/0B_31K_MP92hURjZxTkxUTFZnMVk/edit?pli=1
15.  Taleb, Nassim. “Silent Risk: Lectures On Fat Tails, Antifragility, and Asymmetrical Exposures”. New York University Polytechnic Institute School of Engineering Department of Finance and Risk Engineering.  February 19, 2014. http://www.fooledbyrandomness.com/FatTails.html 
16.  Wagner, Gernot and Weitzman, Martin. “Was Hurricane Sandy the “Fat Tail” of Climate Change?” The Wall Street Journal. November 1, 2012. http://blogs.wsj.com/ideas-market/2012/11/01/was-hurricane-sandy-the-fat-tail-of-climate-change/
17.  Weitzman, Martin. “Fat Tails And The Economics of Climate Change: Fat-Tailed Uncertainty In The Economics Of Catastrophic Climate Change”. Review of Environmental Economics and Policy, Volume 5, Issue 2 Pages 275-292. Summer 2011. http://scholar.harvard.edu/files/weitzman/files/fattaileduncertaintyeconomics.pdf


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