Protecting against black swans

“To bear trials with a calm mind robs misfortune of its strength and burden.” – Seneca

A black swan event is a sudden large deviation event which results in high volatility. Such events occur rarely and are difficult to predict. Most human social interactions and natural systems follow this rule.

In nature, this phenomenon is known as self-organized criticality. It is known that, for example, earthquakes are notoriously difficult to predict.

475pxshutterstock_73975594

Physicists have made several observations and experiments on certain systems such as sandpiles. Based on these, it was concluded that when building up a sandpile, as the number of grains of sand increased, after a certain point – known as the criticality – avalanches began to occur.

These sand avalanches occurred in different places and varied in number and intensity. It is difficult to come up with any sort of equation or algorithm to accurately predict these avalanches. Every avalanche is triggered by a certain grain of sand based on it’s position and the state of it’s neighbors.

At the beginning, when the sandpile is being built, it is still relatively flat and there are few disturbances. But at a certain point, a criticality is reached which makes the system susceptible to avalanches.

Another important observation is that though there are many avalanches, the high intensity ones are fewer but very devastating.

earthquake-result

In nature, the phenomenon of earthquakes follows the Gutenberg-Richter law which describes the relationship between the magnitude and number of occurrences of earthquakes. This is a power law, which means there is an exponential relationship between the magnitude and the number of occurrences. There are a large number of low intensity earthquakes happening all the time. But the high intensity ones only occur very rarely but cause catastrophic destruction.

Such a phenomenon is not limited to nature. Whenever and wherever humans (also technically part of nature) interact in large numbers, i.e., whenever socioeconomics is involved, a similar non-normal, non-Gaussian distribution is observed.

As a side note, the normal distribution was originally used as a way to come up with actuarial tables with average human life expectancies etc to figure out how much premium to charge people so that insurance companies can make profits. However, when natural catastrophes like earthquakes and floods occur, most insurance companies either refuse to pay or go bankrupt.

So, a non-normal, power law distribution is seen in human socioeconomic history. Rare events occur unexpectedly and change the course of history. For example, no one could have predicted the Mongol invasions of Genghis Khan and sack of Baghdad, which ended the golden age of Islam. Events such as the Great Depression and the late 2000s recession also could not have been predicted but they caused immense damage nonetheless.

In 2008, the Lehman Brothers collapsed and could not honor the commercial paper issued by large US corporations, which meant they could not meet payroll. This potential disaster was averted by Federal government intervention.

0681866

It is evident from history that it is impossible for any government intervention to predict or prevent such socioeconomic catastrophes.

However the concept of antifragility helps to think of systems which have some properties which actually love randomness and volatility. For example, human bones are strengthened with the application of small stressors (like sprinting or deadlifting). Of course the application of a 1000 pound stressor would be deadly. So our bones are antifragile to relatively small stressors and fragile to both inactivity (causing brittleness) or immense stressors.

Similarly, a political system like Switzerland has lasted for nearly eight hundred years in spite of massive wars and destruction going on all around it. One reason could be the Canton system where the local government bodies hold each other together with trade and mutual economic benefit. There is minimal centralized federal government. Compare this with a centralized massive system like the USSR which collapsed in a matter of decades.

Note that an antifragile system is different from a robust system in that a robust system does not gain or benefit from volatility, but an antifragile system does. A fragile system, on the other hand, cannot stand any volatility and is immensely harmed by it.

From an individual standpoint, the philosophy of stoicism could perhaps be considered an antifragile philosophy. Stoicism is a system of personal ethics which gives utmost importance to how one reacts to the world rather than what the world does or doesn’t. A core concept is apatheia, which means equanimity. Similar ideas are found in Buddhist and Vedantic philosophies. These philosophies advise their followers to maintain equanimity in the face of joy and sadness and to develop patience.

Overall, thinking about building antifragile systems is important. This is both from an individual and socioeconomic standpoint. Such thinking may help to reduce fragility and reduce exposure to human-caused black swans. When it comes to nature-caused black swans like earthquakes, floods, tsunamis, tornadoes (having witnessed the aftermath of a tornado) I am not aware of things which could protect against such things.