Sudip Bandyopadhyay’s Blog

Nassim Taleb has benefited hugely from walking his talk. If talking about black swans has proven rewarding (in terms of global notoriety and royalties) since the publication of his memorable book, “Black Swan” walking it has recently delivered rich pickings in monetary terms. Perhaps most relevant to him, it has also finally vindicated a life devoted to the study and pursuit of the inexplicable rare event. Universa Investments, a firm run by two of Mr Taleb’s protégés who receive advice from their mentor, had as of mid-October posted yearly returns of at least 50 per cent and as much as 110 per cent. During the same period, the S&P 500 fell by 40 per cent and markets worldwide disappointed intensely.

In the conventional finance theory (the one taught at business schools for 50 years, regularly embraced by quantitative risk managers and typically sanctioned by regulators), the most sacred tenets of financial economics are based on the notions that we can measure things like risk, expected loss and correlation in the markets, and that asset returns will follow a normal path that rules out the possibility of even the most modest of abnormal moves. If the credit crisis shows something, it is that these tenets are as discredited as an Enron balance sheet.

Perhaps it is high time to put to rest the notions that we can mathematically map the markets and that nasty surprises are not supposed to happen. After all, Bear Stearns and Lehman Brothers are no longer with us. When faced with all this, there is a group of people in Sweden who must be feeling slightly queasy. The Central Bank of Sweden, in clear defiance of Alfred Nobel’s legacy and express wishes, has for four decades been granting something called The Sveriges Riksbank Prize in Economic Sciences to an assorted bunch of equation-loving theoreticians. Three of those awards have gone to contributions by financial economists, all solid testaments to the belief that we can quantitatively measure and predict and that the probability distribution is normal. According to such dogmatism, an asset’s standard deviation (sigma) is a good description of its riskiness and future turbulence. According to such dogmatism, the crisis didn’t happen. According to such dogmatism, Universa never posted those returns. Sadly for our Viking friends, sigma never had a chance of “measuring” trouble, the crisis very much took place, and Mr Taleb raked in the millions while Mr Buffett lost them.