Black Swan Theory And The Banks Defective Models
Isaac Hayes - 23-Oct-2009
Black Swan Theory, also known as Black Swan Events concerns itself with high impact and hard to predict rare events beyond the realm of normal expectations.
The theory was described by NASSIM NICHOLAS TALEB, essayist and former mathematical trader and distinguished professor of risk engineering at New York University's Polytechnic Institute in his 2007 book "The Black Swan".
Taleb contends that banks and trading firms are very vulnerable to hazardous Black Swan events and are therefore exposed to losses beyond that predicted by their defective models.
Nassim Taleb also regards almost all major scientific discoveries, historical events and artistic accomplishments as "black swans". Undirected and unpredicted and if we think about any particulars reason for the reason, for the reason by infinite, it all becomes clear that it has no end.
As a researcher in probability, Nassim Taleb certainly has some credibility. In 2006, using FNMA and bank risk managers as his prime perpetrators, he wrote the following about the government-sponsored institution "Fannie Mae".
When I look at its risks, they seem to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup. But not to worry: their large staff of scientists deemed these events unlikely.
Taleb seems to be saying in today's conditions you want a maximum amount of zero-risk securities, but whether that is cash, bonds, dividend-paying stocks, property, or gold bullion is where the debate lies. He also seems to recommend you have a small amount of risk capital in maximum risk securities.
In banking, all the low-probability events tend to have catastrophic consequences and when they do occur, you are exposed to maximum risk. Great examples are the Russian loan defaults and the subprime market melt down.
The probability is remote, but the magnitude of an occurrence is a portfolio destroyer.
