The rule - what you don't do is more important than what you do. In natural systems, you need redundancy to make the system work better. People think that redundancies are inefficient. I think they're the most efficient thing in the world, if you do them right.
Redundancy is bad if you buy the same morning newspaper twice or if you have two subscriptions to the same website. But redundancy is fine if you have a stock of cash in the bank or if you're a company that needs oil and you have extra oil.
Let's assume that you have cash in the bank and there's a big crisis. You have dry powder. It will make you antifragile to have the extra dry powder if nobody else has money. You can buy anything you want. Cash is the opposite of leverage.
In fact, the number one indicator of fragility is leverage. It can be operational or financial. Leverage corresponds to people's overconfidence about the future.
Most people who have leverage will be completely squeezed in a crisis, and you will have cash.
Showing posts with label robustness. Show all posts
Showing posts with label robustness. Show all posts
Thursday, September 26, 2013
Saturday, January 19, 2013
Ten Anti-Fragility Principles for a Robust Society
1. What is fragile should break early, while it's still small.
Evolution in economic life helps those with the maximum amount of hidden risks become the biggest.
2. No socialization of losses and privatization of gains.
Whatever may need to be bailed out should be nationalized; whatever does not need to be bailed out should be free, small, and risk-bearing.
3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus.
4. Don't let someone making an "incentive" bonus manage a nuclear plant-or your financial risk.
Bonuses don't accommodate the hidden risks of blowups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.
5. Compensate complexity with simplicity.
Complexity from globalization and highly networked economic life needs to be countered by simplicity in financial products. The complex economy is already a form of leverage. It's the leverage of efficiency. Complex systems survive thanks to slack and redundancy, not debt and optimization. Capitalism cannot avoid fads or bubbles.
6. Do not give children dynamite sticks, even if they come with a warning label.
Complex financial products need to be banned because nobody understands them, and few are rational enough to know it.
7. Only ponzi schemes should depend on confidence. Governments should never need to "restore confidence."
Cascading rumors are a product of complex systems.
8. Do not give an addict more drugs if he has withdrawal pains.
Using leverage to cure the problems of too much leverage is not homeopathy, it's denial.
9. Citizens should not depend on financial assets as a repository of value and should not rely on fallible "expert" advice for their retirement.
Economic life should be definancialized. We should learn not to use markets as warehouses of value. They do not harbor the certainties that normal citizens can require.
10. Make an omelet with a broken egg.
We need to break things down in order to make them more simple, more robust.
Evolution in economic life helps those with the maximum amount of hidden risks become the biggest.
2. No socialization of losses and privatization of gains.
Whatever may need to be bailed out should be nationalized; whatever does not need to be bailed out should be free, small, and risk-bearing.
3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus.
4. Don't let someone making an "incentive" bonus manage a nuclear plant-or your financial risk.
Bonuses don't accommodate the hidden risks of blowups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.
5. Compensate complexity with simplicity.
Complexity from globalization and highly networked economic life needs to be countered by simplicity in financial products. The complex economy is already a form of leverage. It's the leverage of efficiency. Complex systems survive thanks to slack and redundancy, not debt and optimization. Capitalism cannot avoid fads or bubbles.
6. Do not give children dynamite sticks, even if they come with a warning label.
Complex financial products need to be banned because nobody understands them, and few are rational enough to know it.
7. Only ponzi schemes should depend on confidence. Governments should never need to "restore confidence."
Cascading rumors are a product of complex systems.
8. Do not give an addict more drugs if he has withdrawal pains.
Using leverage to cure the problems of too much leverage is not homeopathy, it's denial.
9. Citizens should not depend on financial assets as a repository of value and should not rely on fallible "expert" advice for their retirement.
Economic life should be definancialized. We should learn not to use markets as warehouses of value. They do not harbor the certainties that normal citizens can require.
10. Make an omelet with a broken egg.
We need to break things down in order to make them more simple, more robust.
Phronetic Rules: What is wise to do to mitigate the fourth quadrant
Can't get away from Taleb.
The fourth quadrant is where the difference between absence of evidence and evidence of absence becomes acute. It is where Extremistan mixes with Complexity, aka the Black Swan domain.
He says the most obvious way to exit the fourth quadrant is by "truncating," cutting certain exposures by purchasing insurance, when available, and by putting oneself in a barbell situation, ie. take small amount of big risk and a large amount of little or no risk.
Rules to Increase Robustness
(1) Have respect for time and nondemonstrative knowledge.
(2) Avoid optimization; learn to love redundancy*.
(3) Avoid prediction of small probability payoffs - though not necessarily of ordinary ones.
(4) Beware of "atypicality" of remote events**.
(5) Beware moral hazard with bonus payments***.
(6) Avoid some metrics****.
(7) Positive or negative Black Swan.
(8) Do not confuse absence of volatility with absence of risk.
(9) Beware presentations of risk numbers.
*Redundancy in the financial realm is lots of cash under the mattress. Cash is the opposite of debt.
**This relates to the assumptions underlying MPT and the non-stationarity of the data. He calls scenario analysis and stress testing "sucker methods" because they are based on the past (which is not necessarily a good guide to the future).
***Akin to the asset liability mismatch in banking is the timing mismatch between bonus' paid for short term performance when risks and ultimate demise are increasing over time (moral hazard).
****Conventional metrics (std deviation, linear regression, etc.) based on an assumption of Mediocristan don't apply to the fourth quadrant (Extremistan). The evolution into Extremistan is marked by lowering volatility. Risk perception is subject to framing issues that are acute in the fourth quadrant.
The fourth quadrant is where the difference between absence of evidence and evidence of absence becomes acute. It is where Extremistan mixes with Complexity, aka the Black Swan domain.
He says the most obvious way to exit the fourth quadrant is by "truncating," cutting certain exposures by purchasing insurance, when available, and by putting oneself in a barbell situation, ie. take small amount of big risk and a large amount of little or no risk.
Rules to Increase Robustness
(1) Have respect for time and nondemonstrative knowledge.
(2) Avoid optimization; learn to love redundancy*.
(3) Avoid prediction of small probability payoffs - though not necessarily of ordinary ones.
(4) Beware of "atypicality" of remote events**.
(5) Beware moral hazard with bonus payments***.
(6) Avoid some metrics****.
(7) Positive or negative Black Swan.
(8) Do not confuse absence of volatility with absence of risk.
(9) Beware presentations of risk numbers.
*Redundancy in the financial realm is lots of cash under the mattress. Cash is the opposite of debt.
**This relates to the assumptions underlying MPT and the non-stationarity of the data. He calls scenario analysis and stress testing "sucker methods" because they are based on the past (which is not necessarily a good guide to the future).
***Akin to the asset liability mismatch in banking is the timing mismatch between bonus' paid for short term performance when risks and ultimate demise are increasing over time (moral hazard).
****Conventional metrics (std deviation, linear regression, etc.) based on an assumption of Mediocristan don't apply to the fourth quadrant (Extremistan). The evolution into Extremistan is marked by lowering volatility. Risk perception is subject to framing issues that are acute in the fourth quadrant.
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