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Learning to Love Volatility: Nassim Nicholas Taleb on the Antifragile
November 16, 2012 | WSJ | Nassim Nicholas Taleb

In a world that constantly throws big, unexpected events our way, we must learn to benefit from disorder, writes Nassim Nicholas Taleb.

Some made the mistake of thinking that I hoped to see us develop better methods for predicting black swans. Others asked if we should just give up and throw our hands in the air: If we could not measure the risks of potential blowups, what were we to do? The answer is simple: We should try to create institutions that won't fall apart when we encounter black swans—or that might even gain from these unexpected events....To deal with black swans, we instead need things that gain from volatility, variability, stress and disorder. My (admittedly inelegant) term for this crucial quality is "antifragile." The only existing expression remotely close to the concept of antifragility is what we derivatives traders call "long gamma," to describe financial packages that benefit from market volatility. Crucially, both fragility and antifragility are measurable.

As a practical matter, emphasizing antifragility means that our private and public sectors should be able to thrive and improve in the face of disorder. By grasping the mechanisms of antifragility, we can make better decisions without the illusion of being able to predict the next big thing. We can navigate situations in which the unknown predominates and our understanding is limited.

Herewith are five policy rules that can help us to establish antifragility as a principle of our socioeconomic life.

Rule 1:Think of the economy as being more like a cat than a washing machine.

We are victims of the post-Enlightenment view that the world functions like a sophisticated machine, to be understood like a textbook engineering problem and run by wonks. In other words, like a home appliance, not like the human body. If this were so, our institutions would have no self-healing properties and would need someone to run and micromanage them, to protect their safety, because they cannot survive on their own.

By contrast, natural or organic systems are antifragile: They need some dose of disorder in order to develop. Deprive your bones of stress and they become brittle. This denial of the antifragility of living or complex systems is the costliest mistake that we have made in modern times.

Rule 2:Favor businesses that benefit from their own mistakes,not those whose mistakes percolate into the system.

Some businesses and political systems respond to stress better than others. The airline industry is set up in such a way as to make travel safer after every plane crash.

Rule 3:Small is beautiful, but it is also efficient.

Experts in business and government are always talking about economies of scale. They say that increasing the size of projects and institutions brings costs savings. But the "efficient," when too large, isn't so efficient. Size produces visible benefits but also hidden risks; it increases exposure to the probability of large losses.
Rule 4:Trial and error beats academic knowledge.
Rule 5:Decision makers must have skin in the game.

In the business world, the solution is simple: Bonuses that go to managers whose firms subsequently fail should be clawed back, and there should be additional financial penalties for those who hide risks under the rug. This has an excellent precedent in the practices of the ancients. The Romans forced engineers to sleep under a bridge once it was completed (jk: personal risk and skin in the game).
Nassim_Taleb  resilience  black_swan  volatility  turmoil  brittle  antifragility  personal_risk  trial_&_error  unknowns  size  unexpected  economies_of_scale  risks  hidden  compounded  disorder  latent  financial_penalties  Romans  skin_in_the_game  deprivations  penalties  stressful  variability 
november 2012 by jerryking
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