What Is a Black Swan?
Let me explain what a black swan is: it's an unpredictable event that goes beyond normal expectations and can have severe consequences. These events are extremely rare and unpredictable, stepping outside of what we usually anticipate. They're known for their potentially huge impact and the common hindsight bias where people insist they were obvious all along.
You've probably heard examples like the 2008 housing market crash that triggered the Great Recession. Others include the COVID-19 pandemic, the September 11 terrorist attacks, and Zimbabwe's hyperinflation crisis.
Key Takeaways
A black swan is an extremely rare event with potentially severe consequences. It can't be predicted ahead of time, but afterward, many falsely claim it should have been foreseeable. These events can cause catastrophic damage to economies by harming markets and investments, and even robust modeling can't prevent them. Relying on standard forecasting tools can fail to predict them and might even heighten vulnerability by spreading risk and giving a false sense of security. The term gained popularity through Nassim Nicholas Taleb's book, The Black Swan.
Understanding a Black Swan
The term comes from Nassim Nicholas Taleb, a finance professor, writer, and former Wall Street trader. He discussed black swan events in his 2007 book before the 2008 financial crisis hit. Taleb's point is that since these events are impossible to predict due to their rarity but have catastrophic effects, you should always assume one could happen and plan for it. Some think diversification might offer protection if one occurs.
Taleb used the 2008 crisis to argue that letting a broken system fail can strengthen it against future black swans. On the flip side, propping up a system and shielding it from risk makes it more vulnerable to rare, unpredictable events.
Taleb defines a black swan as an event that's so rare its possibility is unknown, has a catastrophic impact when it happens, and gets explained in hindsight as if it were predictable. For such rare events, standard probability tools like the normal distribution don't work because they rely on large samples that aren't available. Using stats from past events to extrapolate won't help predict black swans and might make us more susceptible to them.
The final key aspect is that as historically significant events, people love to explain them after the fact and speculate on how they could have been predicted. But this retrospective analysis doesn't aid in forecasting future ones, which could be anything from a credit crisis to a war.
Black Swans and the Housing Market Crash
One of the most cited black swan examples is the 2008 housing market crash. It happened right after Taleb's book and fit his description perfectly: Before it, calculating the probability of a housing bubble was impossible, despite the dire economic fallout. After the bubble burst, experts offered explanations claiming the collapse was inevitable, yet only a few had foreseen it.
Other Examples of Black Swan Events
A black swan is any event that seems highly unlikely beforehand but inevitable in retrospect. This is subjective, but here are some often-cited ones.
Examples
- Hyperinflation in Zimbabwe: In 2008, Zimbabwe saw the worst 21st-century hyperinflation with rates over 79.6 billion percent, nearly impossible to predict and devastating to the economy.
- Tech Bubble: The 2001 dotcom bubble involved rapid growth and wealth increases before a catastrophic collapse, fueled by investments in nascent internet companies with inflated valuations.
- Collapse of LTCM: In 1998, hedge fund Long-Term Capital Management failed due to ripple effects from Russia's debt default, which their models couldn't predict.
- COVID-19 Pandemic: The 2020 emergence of COVID-19 disrupted global markets and economies unexpectedly.
What Is a Black Swan Event in the Stock Market?
In the stock market, a black swan is often a crash exceeding six standard deviations, making it probabilistically rare. Some argue stock prices have 'fat tails,' meaning such events are more common than statistics suggest.
Why Do They Call It a Black Swan Event?
Black swans are rare since most swans are white. The story is that black swans were once thought not to exist until one was found, teaching that what we see as very rare might be more common.
What Is a Grey Swan Event?
A grey swan is an outlier more probable than a black swan, so people can prepare and hedge against it better.
The Bottom Line
A black swan event is a consequential occurrence almost impossible to predict, yet it seems inevitable afterward. These can disrupt stock markets hugely, where investors pour resources into predicting the unpredictable.
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