Antifragile: Things That Gain from Disorder

by Taleb, Nassim Nicholas

  CONFLATION

  Of course, so many things are not the same “ting” in life. Let us generalize the conflation.

  This lesson “not the same thing” is quite general. When you have optionality, or some antifragility, and can identify betting opportunities with big upside and small downside, what you do is only remotely connected to what Aristotle thinks you do.

  There is something (here, perception, ideas, theories) and a function of something (here, a price or reality, or something real). The conflation problem is to mistake one for the other, forgetting that there is a “function” and that such function has different properties.

  Now, the more asymmetries there are between the something and the function of something, then the more difference there is between the two. They may end up having nothing to do with each other.

  This seems trivial, but there are big-time implications. As usual science—not “social” science, but smart science—gets it. Someone who escaped the conflation problem is Jim Simons, the great mathematician who made a fortune building a huge machine to transact across markets. It replicates the buying and selling methods of these sub–blue collar people and has more statistical significance than anyone on planet Earth. He claims to never hire economists and finance people, just physicists and mathematicians, those involved in pattern recognition accessing the internal logic of things, without theorizing. Nor does he ever listen to economists or read their reports.

  The great economist Ariel Rubinstein gets the green lumber fallacy—it requires a great deal of intellect and honesty to see things that way. Rubinstein is one of the leaders in the field of game theory, which consists in thought experiments; he is also the greatest expert in cafés for thinking and writing across the planet. Rubinstein refuses to claim that his knowledge of theoretical matters can be translated—by him—into anything directly practical. To him, economics is like a fable—a fable writer is there to stimulate ideas, indirectly inspire practice perhaps, but certainly not to direct or determine practice. Theory should stay independent from practice and vice versa—and we should not extract academic economists from their campuses and put them in positions of decision making. Economics is not a science and should not be there to advise policy.

  In his intellectual memoirs, Rubinstein recounts how he tried to get a Levantine vendor in the souk to apply ideas from game theory to his bargaining in place of ancestral mechanisms. The suggested method failed to produce a price acceptable to both parties. Then the fellow told him: “For generations, we have bargained in our way and you come and try to change it?” Rubinstein concluded: “I parted from him shamefaced.” All we need is another two people like Rubinstein in that profession and things will be better on planet Earth.

  Sometimes, even when an economic theory makes sense, its application cannot be imposed from a model, in a top-down manner, so one needs the organic self-driven trial and error to get us to it. For instance, the concept of specialization that has obsessed economists since Ricardo (and before) blows up countries when imposed by policy makers, as it makes the economies error-prone; but it works well when reached progressively by evolutionary means, with the right buffers and layers of redundancies. Another case where economists may inspire us but should never tell us what to do—more on that in the discussion of Ricardian comparative advantage and model fragility in the Appendix.

  The difference between a narrative and practice—the important things that cannot be easily narrated—lies mainly in optionality, the missed optionality of things. The “right thing” here is typically an antifragile payoff. And my argument is that you don’t go to school to learn optionality, but the reverse: to become blind to it.

  PROMETHEUS AND EPIMETHEUS

  In Greek legend, there were two Titan brothers, Prometheus and Epimetheus. Prometheus means “fore-thinker” while Epimetheus means “after-thinker,” equivalent to someone who falls for the retrospective distortion of fitting theories to past events in an ex post narrative manner. Prometheus gave us fire and represents the progress of civilization, while Epimetheus represents backward thinking, staleness, and lack of intelligence. It was Epimetheus who accepted Pandora’s gift, the large jar, with irreversible consequences.

  Optionality is Promethean, narratives are Epimethean—one has reversible and benign mistakes, the other symbolizes the gravity and irreversibility of the consequences of opening Pandora’s box.

  You make forays into the future by opportunism and optionality. So far in Book IV we have seen the power of optionality as an alternative way of doing things, opportunistically, with some large edge coming from asymmetry with large benefits and benign harm. It is a way—the only way—to domesticate uncertainty, to work rationally without understanding the future, while reliance on narratives is the exact opposite: one is domesticated by uncertainty, and ironically set back. You cannot look at the future by naive projection of the past.

  This brings us to the difference between doing and thinking. The point is hard to understand from the vantage point of intellectuals. As Yogi Berra said, “In theory there is no difference between theory and practice; in practice there is.” So far we have seen arguments that intellect is associated with fragility and instills methods that conflict with tinkering. So far we saw the option as the expression of antifragility. We separated knowledge into two categories, the formal and the Fat Tonyish, heavily grounded in the antifragility of trial and error and risk taking with less downside, barbell-style—a de-intellectualized form of risk taking (or, rather, intellectual in its own way). In an opaque world, that is the only way to go.

  Table 4 summarizes the different aspects of the opposition between narrating and tinkering, the subject of the next three chapters.

  Click here for a larger image of this table.

  All this does not mean that tinkering and trial and error are devoid of narrative: they are just not overly dependent on the narrative being true—the narrative is not epistemological but instrumental. For instance, religious stories might have no value as narratives, but they may get you to do something convex and antifragile you otherwise would not do, like mitigate risks. English parents controlled children with the false narrative that if they didn’t behave or eat their dinner, Boney (Napoleon Bonaparte) or some wild animal might come and take them away. Religions often use the equivalent method to help adults get out of trouble, or avoid debt. But intellectuals tend to believe their own b***t and take their ideas too literally, and that is vastly dangerous.

  Consider the role of heuristic (rule-of-thumb) knowledge embedded in traditions. Simply, just as evolution operates on individuals, so does it act on these tacit, unexplainable rules of thumb transmitted through generations—what Karl Popper has called evolutionary epistemology. But let me change Popper’s idea ever so slightly (actually quite a bit): my take is that this evolution is not a competition between ideas, but between humans and systems based on such ideas. An idea does not survive because it is better than the competition, but rather because the person who holds it has survived! Accordingly, wisdom you learn from your grandmother should be vastly superior (empirically, hence scientifically) to what you get from a class in business school (and, of course, considerably cheaper). My sadness is that we have been moving farther and farther away from grandmothers.

  Expert problems (in which the expert knows a lot but less than he thinks he does) often bring fragilities, and acceptance of ignorance the reverse.3 Expert problems put you on the wrong side of asymmetry. Let us examine the point with respect to risk. When you are fragile you need to know a lot more than when you are antifragile. Conversely, when you think you know more than you do, you are fragile (to error).

  We showed earlier the evidence that classroom education does not lead to wealth as much as it comes from wealth (an epiphenomenon). Next let us see how, similarly, antifragile risk taking—not education and formal, organized research—is largely responsible for innovation and growth, while the story is dressed up by textbook writers. It does
not mean that theories and research play no role; it is that just as we are fooled by randomness, so we are fooled into overestimating the role of good-sounding ideas. We will look at the confabulations committed by historians of economic thought, medicine, technology, and other fields that tend to systematically downgrade practitioners and fall into the green lumber fallacy.

  1 The halo effect is largely the opposite of domain dependence.

  2 At first I thought that economic theories were not necessary to understand short-term movements in exchange rates, but it turned out that the same limitation applied to long-term movements as well. Many economists toying with foreign exchange have used the notion of “purchasing power parity” to try to predict exchange rates on the basis that in the long run “equilibrium” prices cannot diverge too much and currency rates need to adjust so a pound of ham will eventually need to carry a similar price in London and Newark, New Jersey. Put under scrutiny, there seems to be no operational validity to this theory—currencies that get expensive tend to get even more expensive, and most Fat Tonys in fact made fortunes following the inverse rule. But theoreticians would tell you that “in the long run” it should work. Which long run? It is impossible to make a decision based on such a theory, yet they still teach it to students, because being academics, lacking heuristics, and needing something complicated, they never found anything better to teach.

  3 Overconfidence leads to reliance on forecasts, which causes borrowing, then to the fragility of leverage. Further, there is convincing evidence that a PhD in economics or finance causes people to build vastly more fragile portfolios. George Martin and I listed all the major financial economists who were involved with funds, calculated the blowups by funds, and observed a far higher proportional incidence of such blowups on the part of finance professors—the most famous one being Long Term Capital Management, which employed Fragilistas Robert Merton, Myron Scholes, Chi-Fu Huang, and others.

  CHAPTER 15

  History Written by the Losers

  The birds may perhaps listen—Combining stupidity with wisdom rather than the opposite—Where we look for the arrow of discovery—A vindication of trial and error

  Because of a spate of biases, historians are prone to epiphenomena and other illusions of cause and effect. To understand the history of technology, you need accounts by nonhistorians, or historians with the right frame of mind who developed their ideas by watching the formation of technologies, instead of just reading accounts concerning it. I mentioned earlier Terence Kealey’s debunking of the so-called linear model and that he was a practicing scientist.1 A practicing laboratory scientist, or an engineer, can witness the real-life production of, say, pharmacological innovations or the jet engine and can thus avoid falling for epiphenomena, unless he was brainwashed prior to starting practice.

  I have seen evidence—as an eyewitness—of results that owe nothing to academizing science, rather evolutionary tinkering that was dressed up and claimed to have come from academia.

  Click here for a larger image of this table.

  Long before I knew of the results in Table 5, of other scholars debunking the lecturing-birds-how-to-fly effect, the problem started screaming at me, as follows, around 1998. I was sitting in a Chicago restaurant with the late Fred A., an economist, though a true, thoughtful gentleman. He was the chief economist of one of the local exchanges and had to advise them on new, complicated financial products and wanted my opinion on these, as I specialized in and had published a textbook of sorts on the so-called very complicated “exotic options.” He recognized that the demand for these products was going to be very large, but he wondered “how traders could handle these complicated exotics if they do not understand the Girsanov theorem.” The Girsanov theorem is something mathematically complicated that at the time was only known by a very small number of persons. And we were talking about pit traders who—as we saw in the last chapter—would most certainly mistake Girsanov for a vodka brand. Traders, usually uneducated, were considered overeducated if they could spell their street address correctly, while the professor was truly under the epiphenomenal impression that traders studied mathematics to produce an option price. I for myself had figured out by trial and error and picking the brains of experienced people how to play with these complicated payoffs before I heard of these theorems.

  Something hit me then. Nobody worries that a child ignorant of the various theorems of aerodynamics and incapable of solving an equation of motion would be unable to ride a bicycle. So why didn’t he transfer the point from one domain to another? Didn’t he realize that these Chicago pit traders respond to supply and demand, little more, in competing to make a buck, with no need for the Girsanov theorem, any more than a trader of pistachios in the Souk of Damascus needs to solve general equilibrium equations to set the price of his product?

  For a minute I wondered if I was living on another planet or if the gentleman’s PhD and research career had led to this blindness and his strange loss of common sense—or if people without practical sense usually manage to get the energy and interest to acquire a PhD in the fictional world of equation economics. Is there a selection bias?

  I smelled a rat and got extremely excited but realized that for someone to be able to help me, he had to be both a practitioner and a researcher, with practice coming before research. I knew of only one other person, a trader turned researcher, Espen Haug, who had to have observed the same mechanism. Like me, he got his doctorate after spending time in trading rooms. So we immediately embarked on an investigation about the source of the option pricing formula that we were using: what did people use before? Is it thanks to the academically derived formula that we are able to operate, or did the formula come through some antifragile evolutionary discovery process based on trial and error, now expropriated by academics? I already had a hint, as I had worked as a pit trader in Chicago and had observed veteran traders who refused to touch mathematical formulas, using simple heuristics and saying “real men don’t use sheets,” the “sheets” being the printouts of output from the complex formulas that came out of computers. Yet these people had survived. Their prices were sophisticated and more efficient than those produced by the formula, and it was obvious what came first. For instance, the prices accounted for Extremistan and “fat tails,” which the standard formulas ignored.

  Haug has some interests that diverge from mine: he was into the subject of finance and eager to collect historical papers by practitioners. He called himself “the collector,” even used it as a signature, as he went to assemble and collect books and articles on option theory written before the Great War, and from there we built a very precise image of what had taken place. To our great excitement, we had proof after proof that traders had vastly, vastly more sophistication than the formula. And their sophistication preceded the formula by at least a century. It was of course picked up through natural selection, survivorship, apprenticeship to experienced practitioners, and one’s own experience.

  Traders trade → traders figure out techniques and products → academic economists find formulas and claim traders are using them → new traders believe academics → blowups (from theory-induced fragility)

  Our paper sat for close to seven years before publication by an academic economics journal—until then, a strange phenomenon: it became one the most downloaded papers in the history of economics, but was not cited at all during its first few years. Nobody wanted to stir the pot.2

  Practitioners don’t write; they do. Birds fly and those who lecture them are the ones who write their story. So it is easy to see that history is truly written by losers with time on their hands and a protected academic position.

  The greatest irony is that we watched firsthand how narratives of thought are made, as we were lucky enough to face another episode of blatant intellectual expropriation. We received an invitation to publish our side of the story—being option practitioners—in the honorable Wiley Encyclopedia of Quantitative Finance. So we wrote a version of the pre
vious paper mixed with our own experiences. Shock: we caught the editor of the historical section, one Barnard College professor, red-handed trying to modify our account. A historian of economic thought, he proceeded to rewrite our story to play down, if not reverse, its message and change the arrow of the formation of knowledge. This was scientific history in the making. The fellow sitting in his office in Barnard College was now dictating to us what we saw as traders—we were supposed to override what we saw with our own eyes with his logic.

  I came to notice a few similar inversions of the formation of knowledge. For instance, in his book written in the late 1990s, the Berkeley professor Highly Certified Fragilista Mark Rubinstein attributed to publications by finance professors techniques and heuristics that we practitioners had been extremely familiar with (often in more sophisticated forms) since the 1980s, when I got involved in the business.

  No, we don’t put theories into practice. We create theories out of practice. That was our story, and it is easy to infer from it—and from similar stories—that the confusion is generalized. The theory is the child of the cure, not the opposite—ex cura theoria nascitur.

  The Evidence Staring at Us

  It turned out that engineers, too, get sandbagged by historians.

  Right after the previous nauseating episode I presented the joint paper I had written with Haug on the idea of lecturing birds on how to fly in finance at the London School of Economics, in their sociology of science seminar. I was, of course, heckled (but was by then very well trained at being heckled by economists). Then, surprise. At the conclusion of the session, the organizers informed me that, exactly a week earlier, Phil Scranton, a professor from Rutgers, had delivered the exact same story. But it was not about the option formula; it was about the jet engine.