The Black Swan

29 October, 2007

My original intention was to write a longish post discussing the main ideas. Rather I will do an overall impression here, and then do a few follow ups to talk about what I think are the interesting points.

All up I found The Black Swan an very interesting read. If you’ve read fooled by randomness then some of the arguments will have already appeared but certainly not all. The Black Swan is concerned with wild randomness, the randomness that according to Taleb dominates modern society. Fool by randomness largely concerns the randomness of games, what Taleb would describe as mild randomness. So mild that it is hardly random at all.

As we are reminded in several places in the book Taleb made his fuck off money (i.e. enough money to be comfortably independent even if not mega wealthy) in the 87 stockmarket crash betting on the fact that the market under-appreciated Black Swans. He doesn’t need to fawn to the establishment be it economics, philosophy or publishing and we get this tone all through the book.

While the book touches on finance applications its hardly a finance book. Rather Taleb considers it to be as much a work of Epistomology. His chief concern is with what he calls epistemic arrogance. He hates those who profess to know more than they really do know, be they economic modellers, historians or political scientists, but his chief enemy is the normal distribution which is described as the Great Intellectual Fraud. To use normal distributions in fields where it is easy to show are not normal (such as finance), is both fraudulent and causes Black Swans.

Its strong stuff which he backs with examples, logic and the findings of behavioural finance and similar studies. Its also fairly convincing for the most part. Its true we don’t need sophisticated statistical studies to find whether market moves are normally distributed. We only need the fact that we get 1 in 10,000 year events (as modelled by a normal distribution) occurring every few years. Risk managers who run such models (such as me) are either ignorant fools, who actually believe wrongly in what they do, or deceptive frauds who know better but persist in fooling others for the money. I’d contend I’m neither but I’ll discuss later on.

Anyway I leave the rest to further discussion. I particularly want to mention the Narrative Fallacy, which I have actually mentioned before, the problem of prediction as well as whether I really am a fraud, idiot, or neither.

Protecting us from ourselves

14 December, 2006

A friend of mine who has recently become an expectant father, found out that he needed to find out his blood type. For those not aware there can be complications if the mother has an RH negative blood type and the baby has RH positive. The complications can be avoided by some injections, but are also unnecessary if the father is also RH negative as the baby will then always be RH negative as well and there is no risk of reaction. This is the case with my wife and I who are both RH negative.

So anyhow, to avoid unnecessary treatment my friend decided to get his blood type determined only to turn up and discover that they were unable to obtain this simple test without a referral from a doctor, which would of course require an appointment and cash.

Annoyed at this waste of resources he sent off an email to a number of friends, several of whom are medical doctors, complaining bitterly at the waste of his time, his money and the government’s money that was involved in this process.

My immediate (and deliberately provocative) response was that it was due to the closed shop that doctors were running where everything has to be processed by one of the union and I think there is certainly something in that. However I want to explore the response from the doctors.
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Safety, risk and nuclear power

30 November, 2006

It has been pointed out by many people, including on this blog by Sacha (quoting James Lovecock), that nuclear is much safer than pretty much any source of power for electricity. The relevant comparison was that per Terawatt-year of electricity generated there are 342 deaths for coal, 885 deaths for Hydro, 85 deaths from Natural Gas and only 8 for Nuclear. This comparison appears to be using a low figure for the Chernobyl accident as the WHO finds around double that number of deaths directly to the Chernobyl accident, but even so that brings the total to 16 per TWy, still well less than the next most safe method, Natural Gas. Hydro rates poorly due to some severe accidents with dams bursting in India that have killed in the thousands each.

Death of course is not the only risk associated with nuclear. Thousands more have had thyroid cancer directly as a result of Chernobyl although most have been treated and over 99% have recovered it is still a cost to bear. Then there is the contamination of land and the wholesale abandonment of the surrounding area. Also this is not to mention that we don’t really have much historical data to base our estimate of how bad or how frequent a meltdown can be. Still if we look at the total historical human costs and average over all the power that has successfully been generated by nuclear the human cost still comes out as being low, certainly lower than coal power.

If that is the case then isn’t it rational that we should adopt nuclear on the basis of safety? What that kind of comparison misses out is that people regard riskier situations as different to less risky situations for similar expectations. Thus although most nuclear power plants will sit there quite happily not hurting anyone, the rare one that does is potentially extremely hazardous. It is reasonable to treat this volatile outcome as much more serious than the equivalent. We do after all routinely pay away money to insurance companies when we would be better, on an expected outcome basis, to save the money ourselves.

If we believe that nuclear is not just a bit safer (in terms of deaths) than other forms of electricity but significantly safer, then surely this is enough to outweigh our risk aversion? I would say yes, but I could quite easily understand others coming to the no conclusion as well even if they were fairly well informed of the facts and the true risks.

That said I believe it is clear that many people over estimate the risk of nuclear compared with other risks that they don’t even consider or take for granted. On the other hand its also seductively easy to look at nuclear power’s track record in the west and do the reverse. It’s easy to believe there are no black swans if you’ve never seen one. We know catastrophic accidents are rare, but have we been lucky or unlucky seeing as few as we have seen?

The wealthy dead

25 October, 2006

A friend pointed out this new list of the highest earning dead celebrities, and as this article proclaims Elvis has been unseated by Kurt Cobain.

That musicians earn lots after they die comes as no shock, but I am very surprised by number 5 on the list.

Rounding out the top five were Beatle John Lennon at $US24 million ($31.76 million) and groundbreaking physicist Albert Einstein at $US20 million ($26.47 million), whose estate profited from such licensing deals as the popular Baby Einstein educational videos.

You can publish ground breaking work in several areas of physics, win a nobel prize, revolutionise the way we think about space and time and then your decendents make a fortune by lending your name to some children’s educational videos!

Inherited knowledge

20 October, 2006

Some months ago, during the middle of winter, I was sitting on the floor playing with my then roughly five month year old son when my wife came in from outside and stuck her icy hands on me. Mucking around, I pretended to cry, and the next thing my son bursts into tears, something he rarely does if he’s not hungry. Now as far as I can recall he’d never seen anyone else cry up to this point in his life, and we were mystified how he knew that it was an event to be upset about.

So I was looking at this article in The Economist about how our knowledge of facial expressions is likely inherited not learned, and was surprised to see that Charles Darwin had done something similar.

Darwin also believed babies are born able to recognise the facial expressions of others. His first child had suddenly assumed a melancholy expression in an experiment where the maid pretended to weep, even though the boy had apparently never before witnessed another person crying. This, Darwin thought, suggested that his son could not have learned that crying is linked to sadness and must have somehow inherited the knowledge.

Geothermal energy in Iceland

11 October, 2006

Old news, but I didn’t read it at the time and given I’ve mentioned Geothermal energy in Australia before, I thought I’d link to it anyway. The Economist from nearly a month ago mentions some developments that have been making geothermal power at either extreme (low or high temperature) more usable. The low temperature part I think is particularly interesting.

Not all geothermal activity is hot enough to bring water to the boil. The Chena hot springs, in Alaska, for example, are just right for bathers, at a porridge-like 43°C, but not much use for traditional geothermal power generation. Even within the spa’s wells, the water is only 74°C. Nonetheless, its owners, in conjunction with United Technologies, an engineering conglomerate, have worked out how to generate power from the tepid flow—the coldest ever used in a geothermal plant.

The power station at Chena uses the spring water to heat up R134a, a fluid hitherto employed mainly as a refrigerant. Since R134a has a relatively low boiling point, the water is hot enough to convert it into a gas. This gas is used to drive the turbine just as steam would be. Icy water from a nearby river then cools the gas back to liquid form, to start the cycle again.

The designers of the plant at Chena, however, managed to slash their capital outlay by substituting mass-produced parts from air-conditioners for the bespoke components of most geothermal plants. They reckon their design could be mimicked anywhere there is a difference in temperature of at least 50°C between heating and cooling water. That would apply not only to a huge number of geothermal sites, but also to many oil wells, which often bring up warm water from great depths along with their more valuable output.

The idea that you can use off the shelf construction materials to build cheap “warm” power stations is great. These could be much more widely available than the current deep hot rocks that we are drilling for in Australia is interesting. I’m increasingly convinced that some mix of geothermal is going to be an important part of our greenhouse friendly energy usage in the future along with distributed wind power and perhaps nuclear.
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Rainfall patterns

4 October, 2006

While I accept and indeed am concerned about the prospect of global warming, I’ve always been a little bit sceptical of the claim that it will make Australia drier. Naively I expect that if it gets more tropical we’ll get more rain. I also accept that there are many other things happening which may confound this trend. Anyhow I notice via John Quiggin this BOM site, giving maps and time series of annual, monthly etc rainfall for Australia and various other regional breakdowns. John seems to have picked out a graph which makes the browning, appear particularly severe, but is it really so?

Too often we are just presented with just the trend, and without knowledge of the variability over time, how any particular result fits in is difficult to understand. For example if we plot the South Eastern Australia average rainfall for the last 100 years we get this
SE Australia annual rainfall

The obvious things to note is that the average for the first 50 years was well below the later part of the graph. Indeed by the standards of the first half of last century recent drought years with the exception of 2002 haven’t been particularly severe. Instead most have been above the average rainfall experienced in the first half of last century.

If we take the years to 1950, we find an average rainfall of 575mm, for the remaining 55 years the average is 625, with the five highest rainfall measurements all falling in the same half of the graph.
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