Black Swan

Posted in Finance, Accounting and Economics Terms, Total Reads: 555
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Definition: Black Swan

Black Swan refers to an event which is completely unexpected, comes as a total surprise and is extremely difficult to predict.


The phrase ‘Black Swan’ was coined by Nassim Nicholas Taleb, a Lebanese- American essayist and risk analyst, in his books ‘Fooled by Randomness’ and ‘The Black Swan’. The later one is described by The Sunday Times as one of the twelve most influential books since World War II. Nassim used this theory to explain:

a. The inordinate effects of the unexpected and unpredictable events on the world of history, finance, technology and science.

b. The inability of human kind to compute the probability of these rare events using the scientific knowledge.

c. The psychological bias, which human kind develops, blinds them to the uncertainties and they become unaware of the enormous effects of these rare events in history.


A highly improbable event which is an outlier, is highly impactful and has retrospective predictability can be classified as a Black Swan event. Retrospective predictability means that once that event occurs, in spite of it being a big deviation from the normal, human kind devises its reasons of occurrence, thus making it predictable.


A Black swan event can be good or bad. Good Black Swan events are generally slow, and remain unnoticed until they are at the peak of their existence such as the rise of Internet in the early nineties. On the other side, the 9/11 incident (the attack on the World Trade Center on September 11, 2001) was a bad black swan event as people never thought that kind of an event to be possible. These type of bad (Black Swan) events are quick and rapid. The Black Swan theory also suggests us how to react to the good and bad events like these. We should take the maximum benefits from the good ones, by completely exposing ourselves to them, while we learn to cope with the bad ones as effectively as possible.


Example: The collapse of Lehman Brothers can be suitably termed as a Black Swan event. It came as a big surprise to the whole world; it brought down the whole world economy with it and the major reason attributed to it was the lack of proper regulatory controls in the American banking industry.

 

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