On Probability, Risk, & Outliers; Fantasy Sleepers, Exogenous Events, Upsets,and The Next Big Thing

In a ‘streaming’ world of trending-now topics, flash crashes, upsets,underdogs, hurricanes, earthquakes, and tsunamis, many of should be questioning; “what is it exactly that we ‘actually’ do know?”  In short, the answer is not much.  But that does very little to help any of us get out of bed with anymore certainty about what to expect ‘today,’ as opposed to any other day.  The issue, I believe, is that the one thing that has eluded us, after a century of rapid innovation, is that we don’t really know all that much.

We are conditioned to look at past events, statistics and forecasts and draw some kind of conclusion about what the future of may hold, based on that information.  I am here to tell you a number of things, not the least of which is that what you think is ‘information’ often isn’t.  Nassim Nicholas Taleb has discussed this at length in his books (‘Fooled by Randomness’ and ‘The Black Swan’), but some of  the reasons his books are so profound are that: 1, they are so in-depth and intellectual that the majority of society will never derive any benefit from them and, 2, that those who can derive benefit from them are unlikely to comprehend the vast applications of this knowledge in their day-to-day life.

This is primarily a consequence of ‘what we think we know’ as opposed to ‘what we know,’ the difference between information and noise, and the notion that what we do ‘know’ about is that history can mean little to nothing as it pertains to ‘predicting’ our future. Secondarily, our failure to understand the difference between ‘low probability’ and ‘low risk’ is perhaps the greatest flaw, and the defining characteristic, of mankind. And, thirdly, our problem of assuming low probability/high impact events are somehow more likely once we’ve experienced them (think 9/11), when the likelihood of them occurring again may actually be remote even as compared to their original probability (The notion that, by virtue of having happened, a repeat of 9/11 occurring is far less likely than the probability of it having occurred in the first place – originally we couldn’t imagine it, now that we can imagine it, it would be harder to surprise us; because we can now actually contemplate that type of attack now.  Think to yourself – Given what we know now, would someone in ‘intelligence’ again dismiss the chances of such an attack if they had a warning?  Of-course not, but the first time they did).

Probability versus Risk:

People have a habit of confusing an events’ probability (The likelihood of an occurrence) with the risk of said event (the impact of its’ affect).  As human beings, we seem hard-wired to associate low-probability events as having low risk – because, there is less ‘risk’ of that event coming to pass.  Unfortunately, however, the reality is; that which we do not expect usually ends up defining our lives.

Now, for a more practical (or philosophical) description of these concepts I will defer to Taleb but, I want to broaden the scope of areas to which we typically attribute this phenomena.  Some of the obvious areas we might expect to find low probability events that carry tremendous impact are:

  • Weather (Hurricanes, Tornadoes)
  • Geological (Earthquakes, Tsunamis, Volcanoes)
  • Financial (Crashes, Depressions, Bankruptcies, Bubbles, and the occasional Divorce [See Tiger Woods])
  • Social (Facebook, Twitter, Civil Rights, Prohibition, and the LA Riots)

There are, however, an ever-growing number of additional areas where we can be increasingly (or world is accelerating faster than we are) clueless as to the impact of what we don’t expect:

  • Financial (Counter-Party Risk, Layoffs, Leverage, and the occasional Divorce [See Tiger Woods])
  • Consumer (Penicillin, Blood-Letting, Viagra, Napster, Laser-Disk, 3-D (The 1st time), Brandy, LSD, Teflon, and 8-Track tapes)
    • Note: I include not just accidental discoveries and unforeseen successes, but also ‘the next big thing’ that wasn’t.
  • Sports (Fantasy ‘Sleepers,’ 2008 NY Giants, Tom Brady, Kirk Gibson, and the 1980 USA Men’s Hockey Team)
  • Political (Elliot Spitzer, the ‘Tea-party,’ Barack Obama, and Marxist Communism)
  • Geopolitical (The Roman Empire, Christopher Columbus can’t drive, Mussolini, Hitler, Fidel Castro, and Osama Bin Laden)
  • Media (Radio, the Phonograph, Napster, the iTunes store, Howard Stern, Mary Tyler Moore, ‘The Jeffersons,” YouTube, and the Internet)
  • Religion (the very fact that this looks like it doesn’t belong here is why it does – we’re human beings, we blame everything on religion – if a highly unlikely, cataclysmic event occurred, that was man-made, a substantial portion of the population would attribute it to religion [or rather, God]; either to blame it on or to justify it)
  • Social (the 1960’s, Disco, Google, the Beatles, and Paris [Perez] Hilton)
  • And, I’m certain, many more

What we must realize is that in a world where we can derive a measurable benefit from ‘predicting’ a fairly likely event (Super Bowl Winner, company earnings, or next week’s weather) based on observation/study of past events, that we would derive an immeasurable benefit by being able to understand that the most important events [trends, catastrophes, plagues, or inventions] in our lives will be relatively unpredictable. My fiancée told me a few months ago that on our Wedding Day the sun would be setting at precisely 6:29pm, and that pictures needed to be complete before then. Today I learned that, 4 days before my Wedding, that a computer error had somehow left us without a suite for the eve of our Wedding, and that our florist/decor-person somehow did not recall on what day of the week our Wedding is to take place.  The point is, no matter how much you plan, that whatever can go wrong will go wrong (Murphy’s Law) and, more importantly, is what you least expect (e.g. something you thought you planned for).  What I am more concerned with, however, are those things so ‘random’ that they cannot possibly be expected from our past experience. (e.g.  ‘The sun never rises on my Wedding Day.)

Final Thoughts:

We have been conditioned, in part by our very nature to conform and by the globalization of our minds, to over-expect that which we can conceive of (my friend was in a car accident, so I ride in anything with wheels) and under-expect  that which we have no reason to contemplate (the Bubonic Plague, 1929, Dec 7th, 1942, JFK, 9/11, flash-crash, stock prices in late 90’s, real estate prices in mid 2000’s, our opinions of newly elected officials, and the 2008 Giants – what can I say? I bleed blue).  What does second category have in common?  They were things that, for those who were/are most affected, were barely imaginable to most people before the fact – some could have been foreseen, and some not.  What we should consider is that if we could conceive that any of the events I mentioned were even plausible before the fact, that even if they were to occur the ramifications would be reduced by virtue of the fact that we were able to contemplate such a thing.

We did not understand disease at the time of the plague, had we understood how sickness spread then the effect of the outbreak likely would have been reduced.

On the morning of Pearl Harbor some people knew that there were planes inbound, but no one believed there was a way foreign aircraft could have had enough fuel to reach that outpost let alone launch an attack.

Yes, market crashes have happened famously a few times but, it’s always the speed that surprises – we always convince ourselves we know what to look for, and the reason we crash is partly because we didn’t think it could happen that way.

I won’t try to discuss Kennedy, but I will say this:

When the NY Giants met the New England Patriots in the Super Bowl most pundits favored the Pats in a veritable landslide. Bookies across the country fielded odds grossly favoring the unbeaten Pats over the upstart G-Men.  I was baffled.  While I saw that the Pats were far superior, and I knew that if they met 10 times, with those rosters, that the Giants would be lucky to win more than once.  But what I also knew was this: As far as I was concerned there was an extremely low probability that one NFL team could beat another 3 times in one season. The Giants had played and lost to the Patriots not only in the epic Week 17 the clinched an undefeated season for the Pats, but they also were defeated by  the Patriots in the preseason that year.

  • If you viewed that game as a lone event –  a best of one series, then you would not likely contemplate that the odds of the Super Bowl weren’t ‘will the Patriots beat the Giants today?’ But rather, ‘Can the same Patriots coaches, players, and playbook beat this Giants team for a 3rd time in 3 games (in one season)?’
  • Having extra information, such as knowledge of the ‘odds’, seems to prove to be only a danger to ourselves and others.
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