What Is a Black Swan?
Nassim Taleb’s three properties of black swans suggest: Willem de Vlamingh discovered black swans in Australia in 1697. Since a black swan had not been previously observed, Europeans believed that all swans were white. The Roman satirist Juvenal even referred to a black swan to describe something as impossibly rare, much like the modern-day phrase: “When pigs fly.”
How a Black Swan Event Works
The general premise of black swan theory is that unpredictable events can have severe economic or financial market consequences. Importantly, events can be unpredictable due to an accumulation of similar and repetitive experiences. According to Taleb, the black swan problem in its original form is this: “How can we know the future, given [our] knowledge of the past?” In other words, how can we form general conclusions from our specific experiences when we haven’t experienced all there is? Just because we have only seen white swans doesn’t mean that black, pink, or any other-colored ones don’t exist. Taleb illustrates an overreliance on past experience with the example of a turkey that is being raised for Thanksgiving. Over the course of the turkey’s life, it is fed daily, creating an expectation that it will, in fact, be fed the next day. Each day the turkey is fed, the belief is reinforced until the day before Thanksgiving, when it will “incur a revision of belief.” This is a simple and easy-to-understand illustration of the black swan phenomenon. When we continue to experience the same thing, such as seeing only white swans or being fed every day, we tend to believe that will be our experience in the future.
Example of Black Swan Events
To illustrate the other tenets of black swan events—significant economic impact and retrospective predictability—we’ll consider a few examples.
Subprime Mortgage Crisis of 2008
The subprime mortgage crisis that began in 2008, also known as the Great Recession, led to one of the worst economic periods in the history of the United States since the Great Depression. It exhibits all three traits of a black swan.
Dot-Com Bubble of 2001
The stock market rose to unprecedented heights in the late ’90s and very early 2000s as a result of overvalued and overhyped tech companies. The crash that resulted was extreme and, in hindsight, predictable.
Flash Crash of 2010
A flash crash is a sudden and sharp decline in stock prices. The flash crash of 2010 was caused by manipulation of automated trading algorithms, for which British futures trader Navinder Sarao claimed responsibility. One lesson to take from black swan theory is that there are always unknowns that can affect financial markets. It’s therefore prudent to take fundamental precautions by diversifying your investments and holding an asset allocation appropriate for you that is designed to weather market ups and downs.
