Monday, December 8, 2008

The Role Of Randomness

Dr. Nassim Taleb is a writer and scholar who used to be a derivatives trader. In his work, he contends that society overestimates the value of patterns from the past and underestimates randomness in attempting to predict the future. This effect had a direct impact on him as a trader, where he found his peers would rely on past data while he could find profits in taking advantage of this phenomenon.

Here he is explaining how the banking crisis was caused by false confidences in quantitative risk management:

Here is an introduction to Taleb's book, Fooled by Randomness, written by Frank Voisin and re-printed here with permission:

Taleb starts out with the point of the book - to explore luck “disguised and perceived as non-luck (that is, skills).” So many of the successful among us, he argues, are successful due to luck rather than reason. This is true in areas beyond business (e.g. Science, Politics), though it is more obvious in business.

Our inability to recognize the randomness and luck that had to do with making successful people successful is a direct result of our search for pattern. Taleb points to the importance of symbolism in our lives as an example of our unwillingness to accept randomness. We cling to biographies of great people in order to learn how to achieve greatness, and we relentlessly interpret the past in hopes of shaping our future.

Only recently has science produced probability theory, which helps embrace randomness. Though the use of probability theory in practice is almost nonexistent.

Taleb says the confusion between luck and skill is our inability to think critically. We enjoy presenting conjectures as truth and are not equipped to handle probabilities, so we attribute our success to skill rather than luck.

The book is organized into three parts:

  • Part One: Solon’s Warning
  • Part Two: Probability Biases
  • Part Three: Tricks To Help Ourselves

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