Mobs, Messiahs, and Markets

Black Swans and Fat Tails

What we are talking about is fat tails—events that lie so far outside the normal course of events that we tend to push them equally far away in our consciousness, events that are so devastating that when they do occur they cancel out every other consideration. There may be only a very slim chance that the human race will be wiped off the face of the earth, it is true. But it would probably pay us to take that slim chance very seriously.

Why? The reason lies in the deceptive nature of thought—in the way we think about risk. Our thinking has a huge blind spot; it seems to be skewed toward only certain sorts of risk—the risk involved in physical events, where what ends up happening depends on only a few, stable factors. Those events follow what statisticians call a normal distribution, which is a graph of the frequency of events that is curved like a bell. There is a big hump in the middle of the graph, where the average falls, and two tails on either side, where the less normal things happen. Physical phenomena like noise or the movement of photons can be modeled by a bell curve. In a bell curve, the normal event is the one you are likely to get most of the time, the one right in the middle of the hump. The abnormal event, the big outlier that you don't see coming, is out in the tapering ends of the curve. It's the event that happens so rarely that it isn't even reckoned with most of the time.

Now, the normal distribution (the Gaussian, it's called) is the ...