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Nassim Taleb: A map of the limits of statistics

Two days ago while reading the Rational Angle Blog I stumbled upon a new article by Nassim Taleb, author of the Black Swan and Fooled by Randomness. In this article Taleb talks about the perils of Black Swans and the current financial crisis. Taleb also identifies the concept of the “fourth quadrant”-a map to help us avoid falling into Black Swan territory. (Click here to skip the intro and read article)

Article Introduction (Via Edge.org)

Statistical and applied probabilistic knowledge is the core of knowledge; statistics is what tells you if something is true, false, or merely anecdotal; it is the “logic of science”; it is the instrument of risk-taking; it is the applied tools of epistemology; you can’t be a modern intellectual and not think probabilistically—but… let’s not be suckers. The problem is much more complicated than it seems to the casual, mechanistic user who picked it up in graduate school. Statistics can fool you. In fact it is fooling your government right now. It can even bankrupt the system (let’s face it: use of probabilistic methods for the estimation of risks did just blow up the banking system).

Author Background (via wikipedia):

Nassim Taleb is a literary essayist, epistemologist, scholar of randomness and knowledge, researcher, and former practitioner of mathematical finance. As a pioneer of complex financial derivatives, he had as a “day job” a lengthy senior trading and financial mathematics career in New York City‘s Wall Street firms, before he started a second career as a scholar in the epistemology of chance events and focus on his project of mapping how to live and act in a world we do not understand, and how to come to grips with randomness and the unknown –which includes his black swan theory of unexpected rare events.

Article Excerpts (Via Edge.Org):

“In 2006, using FNMA and bank risk managers as his prime perpetrators, he wrote the following:The government-sponsored institution Fannie Mae, when I look at its risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup. But not to worry: their large staff of scientists deemed these events unlikely.”

“Taleb, looking at the cataclysmic situation facing financial institutions today, points out that “the banking system, betting against Black Swans, has lost over 1 Trillion dollars (so far), more than was ever made in the history of banking”.”

It appears that financial institutions earn money on transactions (say fees on your mother-in-law’s checking account) and lose everything taking risks they don’t understand. I want this to stop, and stop now— the current patching by the banking establishment worldwide is akin to using the same doctor to cure the patient when the doctor has a track record of systematically killing them.”