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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