Black Swan Effect
Prof. Dr. Sindhu Shantha Nair
What is Black Swan effect?
Black Swan is a disruptive event or an unexpected and unpredictable event, This event could adversely affect the day to day life due to the sever impact of the event. This can affect the economies and often is commonly used in the finance arena. This metaphor is used from the type of swan that is black in color found in Tasmania and Western Australia. These kinds of events are difficult to predict under the normal circumstances and in the hindsight this appears to have been inevitable. Since it is unexpected it is difficult to be prepared for such events, but at the same time, such events are totally unavoidable. This term was coined from the premise that all swans are white. In 1697 William de Vlamingh, the Dutch explorer, in Australia, found swans with dark plumage and black swans are very rare. Thus, this term black swan was coined as a metaphor to describe or explain any event outside the normal circumstances. It also means that if something has not happened, it does not imply that it may not appear in the future. This analogy of the metaphor is an eye opener towards the fragile nature of human beings, and that of any system, volatility of the market, brittle, anxious, non-linear, and incomprehensible world. Perceptional conclusions of any event may be undone if it is proven wrong. The beauty of this analogous metaphor is that a single black swan which was observed, negated the presumption of the species which was held long term, that all swans are white. Needless to say, that this discovery invalidated the assumption that all swans are white.
An economist and professor and a writer (Nassim Nicholas Taleb) was instrumental in popularizing this term black swan effect in the 21st century, the scope of which extended to historical, scientific and other events. The professor initially explored this context of black swan event in the financial markets. Taleb explained that, human beings often find meaningful information from the environmental stimuli. But the world view is often narrowed. The Cliched beliefs makes humans to accept reality and the truth mapping with the past. This behaviour often becomes a vulnerability to unprecedented events that are called black swan events which essentially calls for a change in the worldview and an acceptance of the reality.
How does Black Swan effect impact people?
Black Swan effect impacts different people at different levels depending on the extent to which they have relevant information about such black swan events. The effect shall be of less impact, if the access to relevant information is more about such events. Taleb further argued that the black swan effect has distinct attributes. First attribute is that it is an outlier so that the possibility of occurrence is unknown. Second attribute is when it occurs, it has a very high impact. Third attribute is that explanations or information about this black swan effect is created once it occurs, in spite of its outlier status so that it is predictable in the future. So such events are considered positive or negative. A disruptive innovation such as internet can be considered positive and events such as a war among countries or world war in the past can be termed negative. Such unpredictable events add to the common body of knowledge. In financial markets the unprecedented financial crisis or recession becomes a black swan and in the stock markets, a market crash becomes the black swan.
What makes human beings susceptible to black swan event?
Most humans are susceptible to black swan event due to the fact that they cling on to the past to create narratives based on the past, and the staunch notion that history repeats or past is a significant predictor of the future. This behaviour makes them search evidential beliefs, which is a confirmation bias. Psychologically, a confirmation bias enables people to decipher information to confirm their existing beliefs or they try to confirm their beliefs to match their expectations. Peter Watson, a psychologist found this term for the psychological phenomenon. This also indicates that humans pick up information that agrees to past or expectations to save time, energy and cost to process information and also helps faster decision making and ignores all information or evidences that contradicts those beliefs and expectations. Essentially black swan makes what is unknown more relevant than what is known or makes what is known irrelevant. This black swan theory calls to gather all information about the world as possible so as to review thoroughly and to avoid such confirmation biases.
Examples of Black Swan Events
In history, the financial crisis in 2008 made the Wall Street suffer unprecedented shocks through plummeting stock prices, lay-offs, closure of banks, government bailout seeking help from central banks. The global financial system collapsed. The dot-com bubble of year 2000 led to the stock market crash, while the internet-based companies and their valuation hit badly. The September 11 attacks in the New York City and Washington Dc, saw the terrorist attacks that destabilized the whole world. This led to market volatility, with a heavy loss of trillion dollars and more. in the stock market. The United States revised the foreign policy post this attack.
All these examples were unprecedented, unwanted surprises and had a major effect. Surprisingly, the Covid 19 pandemic is not considered as a black swan since a global pandemic was expected to eventually take place with a major effect yet considered as a white swan (The New Yorker, 21 April 2020; Taleb Nassim Nicholas, 2009 retrieved 2016). The ten principles for a black swan robust society was provided by Taleb Nassim, in which he stated that a black swan event is dependent on the observer and that the objective needs to be identifying vulnerabilities.
The high impacted black swan event is often inexplainable and unpredictable under normal circumstances and appears to have been inevitable and thus difficult to be prepared for and often is rationalized as unavoidable. Another example is that it was believed that any country through their economic and military alliances shall prevent war from breaking out on even a small scale but country after country became involved in the first world war.
Possibilities of preparedness for Black Swan Events
As the concept and the theory explains this black swan effect is totally unpredictable, the only preparedness is risk management strategies. This risk management strategy should be practiced in all the possible areas especially in the financial context to face unavoidable unprecedented financial adversities.
Business houses can create awareness for risk management and also train strategies of best practices in risk management. All said, there is a surprise adverse element of risk in black swan events, beyond prediction and thus calls for situational risk management and strategies. This applies to organizational and individual risk management strategies also.
The idea is to be prepared for any untoward uncertainties, hoping for the best. Black swan events and effects are bound to happen.
References
Black swan event | Definition, History, Examples, & Facts | Britannica accessed 20 April 2024
“The Pandemic Isn’t a Black Swan but a Portent of a More Fragile Global System”. The New Yorker. 21 April 2020.
Taleb, Nassim Nicholas (25 March 2020). “Corporate Socialism: The Government is Bailing Out Investors & Managers Not You”. medium.com.
