The Statistical Precepts of Nassim Nicholas Taleb

michael edessessThe statistical and investment views of Nassim Nicholas Taleb, author of the blockbuster book The Black Swan, are easy to summarize. First, most probability distributions are fat-tailed, not thin-tailed like the normal distribution. That renders useless or wrong the application of almost all conventional statistical techniques. Second, almost everybody underestimates the likelihood of an extreme tail event, a “Black Swan.” That means there is an opportunity to make money in the long run with a strategy of buying very deep out-of-the-money put options.

His first view is without doubt correct, notwithstanding the apparently unstoppable, widespread overuse of those statistical techniques. His second view is highly debatable and almost impossible to test.

A few years ago Taleb sent me a copy of his book, Statistical Consequences of Fat Tails, following a brief email exchange – though the book is freely available on the internet. In an Advisor Perspectives article later, I promised that I would cover the book in a future article. But I only recently read it. The first thing that surprised me was how heavily mathematical it is – real mathematics, that is, not the kind you find in journals on quantitative finance. Consequently, I will only be able to discuss most of its contents in a general sense in this non-technical article. I’ll get to that in a moment.

My brushes with Taleb

In the spring of 2005, I was living in the touristy town of Sintra, Portugal, writing a book I had tentatively titled The Big Investment Lie. I had no idea where it was going and had little hope of getting a publisher. But it was something I was inspired to do because of an experience I had just had.

Luckily, I did get a publisher several months later, the excellent Berrett-Koehler Publishers. But BK required me to complete a few tasks before it would agree to publish. One was that I had to compare my book to at least five other published books in a similar category and explain how my book added to those.

The most obvious comparison was with Fooled by Randomness by Nassim Nicholas Taleb. It was not easy to explain how my book added something to the message of that book because much of both books were along the same theme, and Taleb’s book covered the ground well.

A few months after my book was published another book came out: The Black Swan by Nassim Nicholas Taleb. With that book, Taleb became a best-selling author, while I didn’t (my book’s sales weren’t bad but it was far from a best-seller). So, in addition to being a Taleb admirer because both Fooled by Randomness and The Black Swan were good reads, I was a bit envious.