Everyone Worries Too Much About 'Black Swans'

In his 2007 book “The Black Swan: The Impact of the Highly Improbable,” finance writer Nassim Nicholas Taleb attempted to educate the public about the danger of rare, unusual events. This is obviously important in the world of finance -- asset market crashes come infrequently, but have an enormous impact on investors’ wealth, and potentially on the economy. Taleb implies that human beings underestimate the risk of these so-called black swans -- in fact, he started one hedge fund (which closed in 2005), and advised another, based on this thesis. But how often do people low ball the odds of catastrophe? And is it possible that we might do the opposite, overestimating the risk of things like stock-market crashes, pandemics and wars?

The problem with rare events is that they’re almost impossible to predict by looking at the past. Usually, when we want to determine how likely something is, we rely on some variation of a basic, classic procedure. We take the frequency that the thing has happened in the past, and this becomes our guess of how likely it is to happen in the future. If Atlanta has had sunny days 74 percent of the time during the past 50 years, then our best guess for the probability of a sunny day in Atlanta is 74 percent. Usually, we bring in other data, like recent global weather patterns or seasonal variations, to help improve the estimate.