# Uncertainty and the Black Swan Theory

Uncertainty touches most aspects of life and economic activity. Decision making under uncertainty and dealing with the unknown has motivated academic research in an effort to understand its multidimensional aspects and implications.

The Black Swan Theory, exposed in The Black Swan – The Impact of The Highly Improbable, a work of Nasim Taleb, is one of those efforts, and its approach to uncertainty and the unknown attracted the attention of the international academia.

This theory presents a critical look on the works over uncertainty of the mainstream economic thought, such as the Expected Utility Hypothesis, developed by Bernoulli and revived in the 20th century. Under this hypothesis a test is made to a consumer who faces a decision between a finite set of mutually exclusive options, each option with a finite and clearly defined set of possible outcomes, and each outcome with a certain known probability. The representative consumer will then chose the option which maximizes his expected utility.

The Black Swan theory turns this framework of analysis upside down. It states that these sterilized models, close to mathematical perfection, are a domestication of the uncertainty with a low descriptive and predictive validity. It falls in what Taleb defines as a ludic fallacy. As Taleb exposes, “In the casino, you know the rules and you can calculate the odds”[1]. This casino uncertainty only exists under an anthropogenic set of rules and tricks such as the rational actors and utility maximization. But people have been shown to make inconsistent choices and systematic “irrational” errors, and Taleb uses the Empirical work of Tversky and Kaneman to show it.

To expose the multidimensionality of uncertainty, Taleb resorts to two hypothetical worlds, the Extremistan and the Mediocristan.

In the Mediocristan, all the uncertainty is domesticated. It is often a physical quantity, which gravitate around a certain range. Adding one person to a 60 people sample will not change significantly the average height of the group, even if it is an outlier. The measures are not scalable, one cannot add zeroes to her income with no greater work. A doctor or a craftsman who wish to raise his labour income, disregarding efficiency changes, needs to work more

In Extremistan the quantities are informational, they have no physical boundaries, “one single observation can disproportionately impact the aggregate”[2]. It is a winner-take-all-world. Incomes are scalable, a stock broker may lose or win a fortune in a day.

The inaccuracy of maximized expected utilities is in its mediocristian’s logics, out of the extremistan world we live in. A world whose history was written by successive Black Swans[3], the phenomena which gives name to the theory. Sterilized Mediocristian’s uncertainty has a poor connection with the real one. Close to everything in social reality is a product of rare but consequential events, and real life does not inform you about the odds. The uncertainty sources are unknown and maximized expected utilities are theoretical abstractions absent form real life.

[1] Taleb, Nassim Nicholas (2010), The Black Swan: The impact of the highly improbable, Penguin Books

[2] ibidem

[3] A black swan is a rare and unpredictable event with an extreme impact, and which may seem explainable in a retrospective analysis. Events such as the rise of the internet, the Perestroika, or the 9/11 are examples of black swan events

750, Gonçalo Pessa