18 January 2008

Taleb on "the irrelevance of 'probability'" (note the quotes!)

Nassim Taleb (author of The Black Swan and Fooled By Randomness, both of which I enjoyed very much), takes on Edge's question for 2008: "What have you changed your mind about?"

His short answer is "The irrelevance of 'probability'". Naturally, I took offense.

It turns out that Taleb is not saying that the theory of probabilities is worthless for real-world situations -- although this would be the sort of thing he would say, and as he has large piles of money which have been made in the markets, perhaps he knows something I don't. It could be the case that probability theory, like any other axiomatic theory, just doesn't reflect what happens in real life. Compare Newtonian mechanics or Euclidean geometry; who will be probability's Einstein or Riemann?

Rather, Taleb is saying that we need to take into account expected value -- the product of probability and payoff. And as I understand it, the funds he manages lose a small amount of money most days -- but they make very large amounts of money on the days they make money, so they come out in the black. (Psychologically, this is hard for human beings to take, because basically we feel sad if we lose money and happy if we make money, and we're not that sensitive to the amounts lost or gained; thus on most days someone with this sort of scheme feels sad. The trick, apparently, is to not look at your portfolio that often; most days you lose, but most months (say) you win.)

More generally, depending on the problem, knowledge of the whole distribution of some random variable can be useful. Of course we can't cut a whole distribution down to a single number. Or even two numbers. Not every distribution is normal.

(Read the rest of the responses to this question, too. A hundred smart people have things to say.)


Anonymous said...

In the financial world, no one who is someone (or better: no one who is not clueless) takes Nassim Taleb seriously. His ideas are not that original as he likes to convey, as many people have thought of that before. To make things worse, he insults people. Let's put things this way: Finance is a lawless territory, and models that are used are wrong ("but some are useful", like someone once said). Using probability is the best people can do to deal with uncertainty... everyone knows it's not accurate, but when you're lost at sea, any hint on how to reach land is welcome. Taleb might have good ideas, but he should be less pompous and more collaborative. I compare his books to Dan Brown's: a bunch of crap that happens to sell.

John Armstrong said...

Controversial financier Nassim Taleb stumbled into a sunken pit in the exchange's trading floor.

Anonymous said...

It is ridiculous to say that 'probability doesn't describe reality' because in fact, probably only has to do with things that sum to 1 or whose integral is 1, and all the implications that follow. Now, just because this jackass applied some distribution to do which it does not in fact come from, in no way detracts from the theory of probability itself. It's all about modeling and choosing the appropriate functions and the inferences and decisions made from application of these functions.

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