precisions by a few decimal places.
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There are more limits I haven’t even attempted to discuss here. I am not even bringing up the class of incomputability people call NP completeness.
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This idea pops up here and there in history, under different names. Alfred North Whitehead called it the “fallacy of misplaced concreteness”, e.g., the mistake of confusing a model with the physical entity that it means to describe.
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These graphs also illustrate a statistical version of the narrative fallacy – you find a model that fits the past. “Linear regression” or “R-square” can ultimately fool you beyond measure, to the point where it is no longer funny. You can fit the linear part of the curve and claim a high R-square, meaning that your model fits the data very well and has high predictive powers. All that off hot air: you only fit the linear segment of the series. Always remember that “R-square” is unfit for Extremistan; it is only good for academic promotion.
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Yogi Berra might have a theory of epilogism with his saying, “You can observe a lot by just watching”.
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While looking at the past it would be a good idea to resist naive analogies. Many people have compared the United States today to Ancient Rome, both from a military standpoint (the destruction of Carthage was often invoked as an incentive for the destruction of enemy regimes) and from a social one (the endless platitudinous warnings of the upcoming decline and fall). Alas, we need to be extremely careful in transposing knowledge from a simple environment that is closer to type 1, like the one we had in antiquity, to today’s type 2, complex system, with its intricate webs of casual links. Another error is to draw casual conclusions from the absence of nuclear war, since, invoking the Casanova argument of Chapter 8, I would repeat that we would not be here had a nuclear war taken place, and it is not a good idea for us to derive a “cause” when our survival is conditioned on that cause.
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This chapter provides a general conclusion for those who by now say, “Taleb, I get the point, but what should I do?” My answer is that if you got the point, you are pretty much there. But here is a nudge.
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Dan Gilbert showed in a famous paper, “How Mental Systems Believe”, that we are not natural skeptics and that not believing required an expenditure of mental effort.
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Make sure that you have plenty of these small bets; avoid being blinded by the vividness of one single Black Swan. Have as many of these small bets as you can conceivably have. Even venture capital firms fall for the narrative fallacy with a few stories that “make sense” to them; they do not have as many bets as they should. If venture capital firms are profitable, it is not because of the stories they have in their heads, but because they are exposed to unplanned rare events.
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There is a finer epistemological point. Remember that in a virtuous Black Swan business, what the past did not reveal is almost certainly going to be good for you. When you look at past biotech revenues, you do not see the superblockbuster in them, and owing to the potential for a cure for cancer (or headaches, or baldness, or bad sense of humor, etc.), there is a small probability that the sales in that industry may turn out to be monstrous, far larger than might be expected. On the other hand, consider negative Black Swan businesses. The track record you see is likely to overestimate the properties. Recall the 1982 blowup of banks: they appeared to the naive observer to be more profitable than they seemed. Insurance companies are of two kinds: the regular diversifiable kind that belongs to Mediocristan (say, life insurance) and the more critical and explosive Black Swan-prone risks that are usually sold to reinsurers. According to the data, reinsurers have lost money on underwriting over the past couple of decades, but, unlike bankers, they are introspective enough to know that it actually could have been far worse, because the past twenty years did not have a big catastrophe, and all you need is one of those per century to kiss the business good-bye. Many finance academics doing “valuation” on insurance seem to have missed the point.
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These scalable laws were already discussed in the scriptures: “For onto everyone that hath shall be given, and he shall have abundance; but from him that hath not shall be taken away even that which he hath”. Matthew (Matthew 25:29, King James Version).
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