Black Swan Event

An event that is impossible to predict

Author: Rohan Arora
Rohan Arora
Rohan Arora
Investment Banking | Private Equity

Mr. Arora is an experienced private equity investment professional, with experience working across multiple markets. Rohan has a focus in particular on consumer and business services transactions and operational growth. Rohan has also worked at Evercore, where he also spent time in private equity advisory.

Rohan holds a BA (Hons., Scholar) in Economics and Management from Oxford University.

Reviewed By: David Bickerton
David Bickerton
David Bickerton
Asset Management | Financial Analysis

Previously a Portfolio Manager for MDH Investment Management, David has been with the firm for nearly a decade, serving as President since 2015. He has extensive experience in wealth management, investments and portfolio management.

David holds a BS from Miami University in Finance.

Last Updated:November 28, 2023

What Is a Black Swan?

A Black Swan Event is essentially an event that nobody saw coming, and it's so unexpected and unlikely that people weren't even aware such a thing could happen. This term is often used in finance, particularly when something really unusual, like a stock market crash, occurs, causing a big ripple effect throughout society.

Nassim Nicholas Taleb coined the term after the 2008 financial crisis. The idea of a "black swan" comes from the belief that black swans didn't exist, as people had only seen white swans. But, surprise! Dutch explorers found black swans in Australia during the 17th century. So, in Taleb's view, black swans symbolize the unknown — events or situations that we shouldn't ignore just because we haven't seen them before.

Taleb discussed these events in his books ‘Fooled By Randomness’ and ‘The Black Swan: The Impact of the Highly Improbable’. According to Taleb, there are three distinct features of black swan events:

  1. The event is unpredictable
  2. The event has a widespread impact
  3. The event is rationalized by hindsight. This means people start claiming they could have expected this to happen (hindsight bias)

Key Takeaways

  • A Black Swan Event is an unexpected and highly improbable occurrence that has a widespread impact, often used in the context of finance and societal events.
  • Positive events with high unpredictability, such as success in movies, publishing, scientific research, and venture capital, are referred to as positive black swan events.
  • Grey swan events are known possibilities with a small perceived probability, while white swan events are predictable.
  • Whether an event is black, grey, or white, understanding and addressing the factors leading to these events is crucial, as they can have long-lasting and transformative effects on society.

Attributes of Black Swan Events

Black swans are not unpredictable because they are random. They are unpredictable because they lie outside our current scope of reasoning. This is why the term ‘black swan’ is used - these swans existed outside what we thought was possible. Taleb teaches us three main lessons in his book:

  1. Black swans impact most of whom have not prepared for the event
  2. Do not use the past as a predictor of the future
  3. Do not treat real-life probabilities in the same way as game probabilities

People who do not see the possibility of the black swan are most adversely affected by its occurrence. 

The large-scale and unprecedented events, like the financial market crash of 2008, would have had a much lesser surprise and impact had we known it was coming. The way we acted would have been different. It is the reason why the event is often rationalized by hindsight.

However, Taleb also advises us against using past patterns to predict the future. We favor patterns of the past as if they are concrete and unchanged. They are poor indicators of the surprising black swan events. If the event had occurred in the past, it is unlikely to be treated as such. 

Although the markets continuously went up until 2007, this would have been a poor predictor of the 2008 crash.

Finally, Taleb also coined the term ‘ludic fallacy.’ The fallacy is related to basing our decisions on probability as if we were playing a game like roulette. Instead, he argues that we could apply statistics in controlled environments where results are visible and defined.

However, this does not apply to the vast number of circumstances and surprises awaiting the real world. Oversimplification, in this case, is worse.

Example of a Black Swan Event

Many large-scale financial crashes can be categorized as black swan events. Examples of some major financial accidents over the past are:

A multitude of factors can explain almost all financial crises. For example, the stock market crash in 1929 led to a decrease in investor confidence. This, in turn, led to decreased spending and consumption. 

Or in 2008, commercial banks failed due to overly risky mortgage-backed securities following the burst of the housing market bubble. 

Such events can be explained retrospectively, but at the time, they were extremely unpredictable and impossible to predict on the societal level.

Some non-financial examples of such events that are commonly referred to include the 9/11. Again, these can be explained due to numerous factors. However, they would likely not have been predicted to occur by many at the time.

Positive black swan events can also occur. Many of the previous examples - including financial and social crises - are negative events. The upside potential is exceptionally high for positive events, while the downside is capped. 

This is converse to negative black swan events. Instead, areas filled with high unpredictability often lead to more positive outcomes.

Taleb highlights several industry areas as having high potential for positive black swans. These include:

He argues that books, for example, have easily controllable downsides while the upsides can make the book popular for any number of reasons. 

To increase the opportunity of encountering potential positive black swan events, one must expose themselves to these industries. Keeping one’s mind open to potential opportunities and seizing potential opportunities is also crucial. 

Therefore, going to dinner parties, first dates, or publishing books are good positive opportunities. The upside far outweighs the downside in many of these cases. The price of publishing a book is small, while the opportunity if the book blows up is extremely good.

Black Swan Vs. Grey Swan vs. White Swan Events

Grey swan events differ from black swans in a few key areas. Primarily, the event is known as a possibility. However, this probability is seen as extremely small. The difference, therefore, is that the outcome is known and predictable. 

There is still the similarity that a grey swan event has the potential to have a significant and widespread impact. For example, natural disasters are predictable outcomes with a small perceived percentage of occurring. 

Multiple choice outcomes, such as the Brexit election of 2016 and Donald Trump’s election, can be seen as grey swan outcomes. This is because the possibility of those outcomes was available, not heavily favored. Grey swans can be both positive and negative. 

Another negative grey swan example is arguably the COVID-19 pandemic. Although the current pandemic was highly unlikely, similar pandemics have occurred in the past. The distinction between the two can sometimes be argued.

As grey swans have somewhat predictable outcomes, the management of grey swans differs. Taleb says that the impacts of negative grey swans, in particular, can be minimized by good risk management. He proposes a term known as ‘anti-fragility’ to make our capacities more than simply robust.

Anti-fragile structures can benefit from adverse shocks rather than just surviving them. For example, maintaining low debt or avoiding it altogether is essential in anti-fragility.

A white swan event is a predictable event. Some argue that even COVID-19 was a white swan event due to the frequency and nature of pandemics. The impact of the event can also be easily estimated.

For example, there are 500m COVID-19 cases with early 7m deaths and a widespread economic impact that cannot be negated. The common feature between black, grey, and white swan events is that they have a large-scale impact on society.

After the fact, white swan events are usually pinpointed to human error. A more pinpoint explanation of why and how certain mistakes led to the event exists. The same can be said for grey swan events. 

However, this does not mean we can ignore the factors leading to white or grey swan events. Both events can have devastating widespread impacts. Regardless of whether the pandemic was a white or grey swan event, it unarguably has shaped much of the modern-day. 

The factors were leading to grey and white swan events, although more predictable, maybe no less fixable than black swan events. The interactions of people inevitably lead to unpredictable outcomes. Here, Taleb argues that anti-fragility is most important.

The table below compares Black Swan, Grey Swan, and White Swan events based on their characteristics, predictability, and impact.

Black Swan Vs. Grey Swan Vs. White Swan

Concept Black Swan Event Grey Swan Event White Swan Event
Probability Extremely low and rare Moderate and foreseeable High and expected
Predictability Unpredictable Partially predictable Highly predictable
Impact Severe and disruptive Significant but manageable Mild and manageable
Awareness Often realized in hindsight Can be anticipated with some analysis Widely expected
Preparation Difficult due to rarity and lack of information Possible with risk management Routine planning
Response strategies Adaptation and resilience Mitigation and preparedness Standard protocols
Market behavior Extreme volatility Moderate fluctuations Stable and predictable
Impact on socio-economic systems May expose systemic flaws May stress existing systems Usually well-handled

Understanding the distinctions between Black Swan, Grey Swan, and White Swan events is crucial for organizations and individuals to effectively anticipate, manage, and respond to various levels of unpredictability and change. 

What is anti-fragility?

Taleb coins the term anti-fragility to try and describe a system that goes beyond simple robustness. He describes it as the following:

“Anti-fragility is beyond resilience or robustness. The resilient resists shocks and stays the same; the anti-fragile gets better.”

He saw robustness or resilience as not perfectly antithetical to fragility. Therefore, he developed a new term that counters fragility more directly. Anti-fragile systems can grow and thrive due to stressors and mistakes rather than just withstanding them. 

Robust systems are shocked and remain the same, even if they can withstand the pressure. Therefore, anti-fragility can be widely applied to a range of fields.

To become anti-fragile is not the same as optimization. While we should look to reduce redundancies in business, becoming more effective is not the same as becoming effective at dealing with fragility and unexpected shocks. In a world of black swans, optimization is not a possibility. 

Anti-fragility has many elements. For one, it is not to be over-reliant on any single asset or income stream. One must not rely on a single product or strategy. 

Rather, maintaining a diversity of income, shareholders, and consumers is essential to keep anti-fragility. This can help minimize debt, which Taleb sees as crucial in not having a fragile business.

Decreasing the reliance chokepoints. This is particularly important in the case of supply chains, which are particularly vulnerable to unexpected catast single factors can also help reduce bottlenecks and crophes. 

By relying on multiple suppliers rather than single ones, supply chain anti-fragility is achieved. A barbell strategy is what Taleb proposes to try and increase our resilience against these events. In business, this would mean dividing investments between riskier and safe investments. 

This helps increase the number of revenue streams while limiting potential downsides. It is a barbell strategy as little focus is given to the middle, only to the extremes.

How can you manage a black swan event?

The feature of these events is that they are distinctly unknown, and therefore people have a difficult time making the correct decisions and adjustments during the shock. Often, a new correct decision must be created in the emergency response rather than finding a previously used decision.

AON, a provider of risk solutions, suggests several strategies a firm can implement to try and best handle a this event:

a) Assume a black swan response team

Have a specialist team filled with interdisciplinary and inter-department members to best navigate a difficult event. In addition, having a team of directly experienced consultants with freak event-related decision-making can provide an invaluable customized approach.

b) Improve risk agility

In the case of these events, senior management must be able to react quickly. Therefore, large amounts of useful and accurate data are important to be handed over to the management. There is also a need to make the information easily digestible.

c) Optimize communications

In times of difficulty, the perception of a firm can look poor and tank its stock. It is essential to maintain reasonable consumer confidence during these events. The firm must use visualization tools and story-telling business intelligence to transmit information effectively.

d) Pursue R&D

R&D is essential when trying to develop a solid solution for difficult situations. The team may be able to conjure solutions to freak events that may have been overlooked or did not previously exist. Rather than efficiency, it is about making new solutions from scratch.

What are the implications of black swan events?

One key implication is that complex models relying on mathematical probabilities may be pointless. This is because normal distribution and other standard probabilistic measures do not necessarily apply to these events, as they rely on several assumptions that do not hold. 

Many statistics rely on the probabilities of past events. However, these are freak events that do not rely on past events or their probabilities. Therefore, doing so may even be more dangerous.

People are also naturally, therefore, blind to surprising events. Psychologically, people are prone to developing ‘collective blindness’ towards black swan events. This means that rather than adapt features of their behavior to deal with black swans, we allow them to occur.

Another psychological feature that occurs is hindsight bias. This stems from one of the features of black swan events, which means people believe that the event could have been rationally predicted and explained. 

People are unrealistic about their expectations of predicting another major event based on the previous major event and are, therefore, unable to deal with another different black swan.

Ultimately, by their very nature, black swans are impossible to predict. Therefore, we cannot use mathematical models or experiences of previous events to prepare for another incident. Instead, we must build up our anti-fragility to deal with unexpected situations.

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