Fooled By Randomness

Paper Details: Nassim Nicholas Taleb (the author) in the book Fooled by Randomness, means by the “black swan principle,” and use that principle to critique the usefulness of the capital asset pricing model (CAPM.)

Randomness, or luck, has been an obsession of men, great and humble alike, since the beginnings of history. In past times, when the Gods made sport of mankind. In present times, still, the role of chance in our lives has been under-appreciated. Whether genetic or cultural, modern man seeks to find patterns and reasons for actions. Nobody wants their success to be attributed to dumb luck — and in cases of tragedy, there is an urgent need to find the cause and assign responsibility.

Concepts like “survivorship bias,” “black swan events,” “fat-tailed distributions” are explained along with clever stock market scams and why the chances of 2 people at a celebration having the similar birthday isn’t as unlikely as you might imagine. He turns the time-honored lament, “if we’re so smart, why aren’t we rich?” on its head: “If you’re so rich, why aren’t you smart?” he asks. More importantly, are successful people good, or just lucky? And most importantly, how can you know?

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A crucial 1st step is to develop a well respect for the power of randomness. The notion that many events have no assignable cause is surprisingly difficult to accept. Perhaps that’s because randomness gets confused with disorder and meaninglessness, both of which are discomforting to most of us. Our brains would rather create nonexistent patterns than be without patterns altogether. But the fact remains that much of what happens in the world is the product of chance. If we don’t learn to appreciate the enormous influence of chance, we will regularly read too much into events.

Derivatives, options, short positions as well as therefore capital asset pricing models are all important elements, but a dominant underlying theme is the concept of “decision making under risk.” That is, how do we decide a course of action when we can’t know the outcome, only its probability? Often, our response to such a situation is informed less by a rational assessment of risk, but by our own individual levels of risk tolerance, and psychological biases with regard to gains as well as losses.

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Derivatives, options, short positions as well as therefore capital asset pricing models are all important elements, but a dominant underlying theme is the concept of “decision making under risk.” That is, how do we decide a course of action when we can’t know the outcome, only its probability? Often, our response to such a situation is informed less by a rational assessment of risk, but by our own individual levels of risk tolerance, and psychological biases with regard to gains as well as losses.

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