is it s o bad that we cannot recognize black swans?

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IS IT SO BAD THAT WE CANNOT RECOGNIZE BLACK SWANS? Fuad Aleskerov and Lyudmila Egorova National Research University Higher School of Economics Zurich, 2011

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Is it s o Bad that we Cannot Recognize Black Swans?. Fuad Aleskerov and Lyudmila Egorova National Research University Higher School of Economics Zurich, 2011. Introduction. A Black Swan: is an outlier , and nothing in the past can convincingly point to its possibility; - PowerPoint PPT Presentation

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Page 1: Is it  s o Bad  that we Cannot Recognize Black Swans?

IS IT SO BAD THAT WE CANNOT RECOGNIZE BLACK

SWANS?

Fuad Aleskerovand Lyudmila Egorova

National Research UniversityHigher School of Economics

Zurich, 2011

Page 2: Is it  s o Bad  that we Cannot Recognize Black Swans?

INTRODUCTION

A Black Swan:

is an outlier, and nothing in the past can convincingly point to its possibility;

carries an extreme impact; has retrospective (though not prospective)

predictability.

Nassim Nicolas Taleb «The Black Swan. The Impact of The Highly Improbable» 2

Page 3: Is it  s o Bad  that we Cannot Recognize Black Swans?

INTRODUCTION

«The central idea of this book concerns our blindness with respect to randomness, particularly the large deviations: Why do we, scientists or nonscientists, hotshots or regular Joes, tend to see the pennies instead of the dollars? Why do we keep focusing on the minutiae, not the possible significant large events, in spite of the obvious evidence of their huge influence?»

Nassim Nicolas Taleb «The Black Swan. The Impact of The Highly Improbable»

3

Page 4: Is it  s o Bad  that we Cannot Recognize Black Swans?

PROBLEM

We will model economic fluctuations representing them as a flows of events of two types:

Q-event reflects the “normal mode” of an economy;

R-event is responsible for a crisis.

The number of events in each time interval has a Poisson distribution with constant intensity.

is the intensity of the flow of regular events Q. is the intensity of the flow of crisis events R. >> holds (that is, Q-type events are far more frequent than the R-type events).

4

Page 5: Is it  s o Bad  that we Cannot Recognize Black Swans?

PROBLEM

We will model economic fluctuations representing them as a flows of events of two types:

Q-event reflects the “normal mode” of an economy;

R-event is responsible for a crisis.

The number of events in each time interval has a Poisson distribution with constant intensity.

is the intensity of the flow of regular events Q. is the intensity of the flow of crisis events R. >> holds (that is, Q-type events are far more frequent than the R-type events).

5

Page 6: Is it  s o Bad  that we Cannot Recognize Black Swans?

PROBLEM

6

Page 7: Is it  s o Bad  that we Cannot Recognize Black Swans?

PROBLEM

X

Q

RThe problem of correct identification (recognition)

Unknown

State of nature

7

Page 8: Is it  s o Bad  that we Cannot Recognize Black Swans?

PROBLEM

X

Q

R

Q

Q

R

R

Player´s perceived identification of the state of nature

8

Page 9: Is it  s o Bad  that we Cannot Recognize Black Swans?

PROBLEM

X

Q

R

Q

Q

R

R

aPayoff of correct identification of regular event

9

Page 10: Is it  s o Bad  that we Cannot Recognize Black Swans?

PROBLEM

X

Q

R

Q

Q

R

R -bIncorrect identification of regular event

10

Page 11: Is it  s o Bad  that we Cannot Recognize Black Swans?

PROBLEM

X

Q

R

Q

R

Q

R

d>>b-d

cc>>a

11

Page 12: Is it  s o Bad  that we Cannot Recognize Black Swans?

PROBLEM

right

right

wrong

wrong

12

Page 13: Is it  s o Bad  that we Cannot Recognize Black Swans?

PROBLEM

How large will be the sum of payoffs received up to time t? 13

Page 14: Is it  s o Bad  that we Cannot Recognize Black Swans?

SOLUTION

Random value Z=∑X of the total sum of the received payoffs during the time t is a compound Poisson type variable.

We give the expression for the expectation of a random variable payoff:

E (Z) = [λ(p 1a – q 1b ) + μ(p 2c – q 2d )] t

14

Page 15: Is it  s o Bad  that we Cannot Recognize Black Swans?

APPLICATION TO REAL DATA

We consider a stock exchange and events Q and R which describe a ‘business as usual’ and a ‘crisis’, respectively.

The unknown event X can be interpreted as a signal received, e.g. by an economic analyst or by a broker, about the changes of the economy that helps him to decide whether the economy is in ‘a normal mode’ or in a crisis.

15

Page 16: Is it  s o Bad  that we Cannot Recognize Black Swans?

PARAMETERS FOR S&P 500

02/08

/1999

22/11

/1999

13/03

/2000

03/07

/2000

23/10

/2000

12/02

/2001

04/06

/2001

24/09

/2001

14/01

/2002

06/05

/2002

26/08

/2002

16/12

/2002

07/04

/2003

28/07

/2003

17/11

/2003

08/03

/2004

28/06

/2004

18/10

/2004

07/02

/2005

30/05

/2005

19/09

/2005

09/01

/2006

01/05

/2006

21/08

/2006

11/12

/2006

02/04

/2007

23/07

/2007

12/11

/2007

03/03

/2008

23/06

/2008

13/10

/2008

02/02

/2009

25/05

/2009

14/09

/2009

0

200

400

600

800

1000

1200

1400

1600

1800

0

2

4

6

8

10

12

14

16

Page 17: Is it  s o Bad  that we Cannot Recognize Black Swans?

PARAMETERS FOR S&P 500

02/08

/1999

22/11

/1999

13/03

/2000

03/07

/2000

23/10

/2000

12/02

/2001

04/06

/2001

24/09

/2001

14/01

/2002

06/05

/2002

26/08

/2002

16/12

/2002

07/04

/2003

28/07

/2003

17/11

/2003

08/03

/2004

28/06

/2004

18/10

/2004

07/02

/2005

30/05

/2005

19/09

/2005

09/01

/2006

01/05

/2006

21/08

/2006

11/12

/2006

02/04

/2007

23/07

/2007

12/11

/2007

03/03

/2008

23/06

/2008

13/10

/2008

02/02

/2009

25/05

/2009

14/09

/2009

0

200

400

600

800

1000

1200

1400

1600

1800

0

2

4

6

8

10

12

14

21.09.200123.07.2002

25.10.2002 21.01.2008

16.10.2008

09.03.2009

30.07.2009

17

Page 18: Is it  s o Bad  that we Cannot Recognize Black Swans?

PARAMETERS FOR S&P 500

02/08

/1999

22/11

/1999

13/03

/2000

03/07

/2000

23/10

/2000

12/02

/2001

04/06

/2001

24/09

/2001

14/01

/2002

06/05

/2002

26/08

/2002

16/12

/2002

07/04

/2003

28/07

/2003

17/11

/2003

08/03

/2004

28/06

/2004

18/10

/2004

07/02

/2005

30/05

/2005

19/09

/2005

09/01

/2006

01/05

/2006

21/08

/2006

11/12

/2006

02/04

/2007

23/07

/2007

12/11

/2007

03/03

/2008

23/06

/2008

13/10

/2008

02/02

/2009

25/05

/2009

14/09

/2009

0

200

400

600

800

1000

1200

1400

1600

1800

0

2

4

6

8

10

12

14

21.09.200123.07.2002

25.10.2002 21.01.2008

16.10.2008

09.03.2009

30.07.2009

18

Page 19: Is it  s o Bad  that we Cannot Recognize Black Swans?

PARAMETERS FOR S&P 500

Estimates for indices with the threshold 6%

Index λ μ a, % -b, % c, % -d, %

S&P 500 246 4 0,6 -0,6 2,8 -2,9

Dow Jones 246 4 0,6 -0,6 1,9 -2,4

CAC 40 243 7 0,8 -0,8 3,0 -2,5

DAX 239 11 0,8 -0,9 2,1 -2,5

Nikkei 225 245 5 0,8 -0,9 2,6 -3,2

Hang Seng 241 9 0,9 -0,9 2,6 -3,0

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Page 20: Is it  s o Bad  that we Cannot Recognize Black Swans?

PARAMETERS FOR S&P 500

In fact, it is enough to identify regular Q-events in almost half of the cases to ensure a positive outcome of the game (q1≤0.46).

E(Z)0

Probability of incorrect identification of crisis R-event

Probability of incorrect recognition of regular Q-event

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Page 21: Is it  s o Bad  that we Cannot Recognize Black Swans?

PROBLEM

21

k

Page 22: Is it  s o Bad  that we Cannot Recognize Black Swans?

MODEL WITH STIMULATIONif

if

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MODEL WITH STIMULATION

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Page 24: Is it  s o Bad  that we Cannot Recognize Black Swans?

MODEL WITH LEARNINGif

if

24

Page 25: Is it  s o Bad  that we Cannot Recognize Black Swans?

CONCLUSION We showed in a very simple model that

with a small reward for the correct (with probability slightly higher than ½) identification of the routine events (and if crisis events are identified with very low probability) the average player's gain will be positive.

In other words, players do not need to play more sophisticated games, trying to identify crises events in advance. 25

Page 26: Is it  s o Bad  that we Cannot Recognize Black Swans?

THANK YOU FOR YOUR ATTENTION!

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