Financial Freedom SG

The big fluctuations in the market recently suggests that all is still not well in the financial markets nor the economy.

With the troubles reported in the news recently about civil unrest in Thailand, huge and unsustainable deficits in the PIGS (Portugal, Italy, Greece and Spain) economies in Europe and now the flare up in the relationships between North and South Korea, is there another black swan coming?

In case you don’t know, a Black Swan event is a term by Nassim Nicholas Taleb to categorize the unpredictable, random and uncertainty that cannot be modelled or projected. This makes us too comfortable when we fall on our mathematical projections and models which fails to take into account random events which has huge implications or cause the entire prediction to fall flat on its face.

It uses the fallacy that “all swans are white” that existed in the past, until the first black swan was sighted. What we can’t see is often more important than what we can see.

I quote from the Wikipedia reference listed below:

Rare and improbable events do occur much more than we dare to think. Our thinking usually is limited in scope and we make assumptions based on what we see, know, and assume. Reality, however, is much more complicated and unpredictable than we think. Also, assumptions relevant to average situations are less relevant to irregular situations, especially when the "rules of the game" themselves do change.

What is more interesting is this quote from him on Globalisation and the damage wrought by a lack of understanding of these types of black swan events  :

Globalization creates interlocking fragility, while reducing volatility and giving the appearance of stability. In other words it creates devastating Black Swans. We have never lived before under the threat of a global collapse. Financial Institutions have been merging into a smaller number of very large banks. Almost all banks are interrelated. So the financial ecology is swelling into gigantic, incestuous, bureaucratic banks – when one fails, they all fall. The increased concentration among banks seems to have the effect of making financial crisis less likely, but when they happen they are more global in scale and hit us very hard. We have moved from a diversified ecology of small banks, with varied lending policies, to a more homogeneous framework of firms that all resemble one another. True, we now have fewer failures, but when they occur ....I shiver at the thought.

The government-sponsored institution Fannie Mae, when I look at its risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup. But not to worry: their large staff of scientists deem these events "unlikely".

The proof of the pie is in the pudding. Mr Taleb

made a multi-million dollar fortune during the financial crisis of 2007–2008, a crisis which he attributed to the failure of statistical methods in finance.Universa, a fund which is based on the "Black Swan" idea and to whom Taleb is a principal adviser, made returns of 65% to 115% in October 2008 in its approximately $2 billion “Black Swan Protection Protocol.

I am reading the Black Swan right now. It is a difficult book to read, so I am taking my time with it. Have been reading it on and off on the MRT university as I commute to and from work and ruminating on it for coming to two weeks now.

I haven’t come to the part of what the solution to this Black Swan problem is, but having read his other book on “Fooled by Randomness,” I have some inkling of what is coming.

Or am I guilty of the prediction error? Maybe a Black Swan solution is coming.

Stay tuned.

By the way, I have no idea if a black swan event is coming, in case you are wondering. I am not a fortune teller, I rather look at the companies.

Anyone tell you different (those of the ‘market is going up’ or ‘market is going down’ kind), is a fortune hunter (hunting your money or hungry for their own fame and glory), not teller :)

Source:

1. The Black Swan by Wikipedia.

2. Nassim Nicholas Taleb by Wikipedia.