Black Swan Event

Develop robustness against negative events and exploit positive events

The black swan theory describes an event that comes as a surprise, has a major effect, and is often inappropriately rationalised after the fact with the benefit of hindsight. Examples of Black Swan events include the rise of the Internet, World War I, dissolution of the Soviet Union, 1987 stock market crash and the September 2001 attacks.

The black swan theory was developed by Nassim Nicholas Taleb (in his 2001 book, ‘Fooled by Randomness’) to explain:

• The disproportionate role of high-profile, hard-to-predict, and rare events.
• The inability to calculate the probability of the rare events due to their rarity.
• The psychological biases that blind people to uncertainty and to a rare event’s massive role in historical affairs.

The phrase ‘black swan’ was a common expression in 16th century London as a statement of impossibility. This was based on the Old World presumption that all swans must be white because all historical records of swans reported that they had white feathers. After Dutch explorer Willem de Vlamingh discovered black swans in Western Australia in 1697, the term changed to mean a perceived impossibility that might later be disproved.

The main idea in Taleb’s book is not to attempt to predict black swan events, but to build robustness against negative ones that occur and be able to exploit positive ones. A company can build robustness with:

• Diversification – Operating several businesses in unrelated industries. This is to be contrasted with mining companies producing one commodity, like iron ore.
• Insurance – Insuring for those rare events like the factory burning down.
• Strong financial base – Low or no debt provides robustness when a black swan event occurs.

Businesses should consider what their back swan event is.