Have You Ever Seen a Black Swan?

by Investing School on August 8, 2011

For a very long time people believed that swans only came in one color: white. When black swans were actually discovered in 1697 in Australia, they were so rare in Europe that their very name became synonymous with the unusual. The concept was expanded into other areas by Nassim Nicholas Taleb in a book by that same name in 2007. Taleb cites three factors which are essential for an event to be considered a “black swan.”

  • The event is a surprise
  • It has a major impact
  • After the first observation, the event is rationalized by hindsight, implying that it could have been expected.

When speaking of the financial world, black swan events can even lead a company to bankruptcy. One of the more commonly cited examples is that of a successful hedge fund, Long Term Capital Management. This fund was rapidly driven to financial ruin when the Russian government defaulted on its debt.

The default is what is viewed as the black swan because no model could have anticipated the actions of the Russian government, much less the effects those actions would have. Computer models can only anticipate what experience has shown has happened already.

Unfortunately, since the events of a black swan are, by definition, random, it isn’t possible to anticipate them. You can, as an investor, prepare for the likelihood of one occurring. Relying solely on forecasts of future events is a chancy proposition at best. Black swans are unusual, but they aren’t that rare that you should ignore the possibility when planning your investment strategy.

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