I

t was unfair really,

but perhaps not altogether unexpected.
On a late October day
in 2001, the English
weather unwilling
to commit to anything discernibly seasonal,
Nassim Nicholas Taleb walks
into the relative comfort of
the Cambridge Union bar

30

and informs those nearest

to the door that the proposition for debate just finished
should have been This house
believes that most city hotshots are lucky fools. Taleb
had been expected to argue
from the less nuanced position that all city hotshots are
lucky fools. He deserved his
drink.
Wilmott magazine

Wilmott magazine

31

TALES OF THE UNEXPECTED

Misunderstood then, misunderstood now. Wall Streets principal

dissident. Heretic! Calvin to finances
Catholic Church. His second book,
the treatise Fooled By Randomness,
drew praise and derision in equal
quantities. Taleb is a breath of fresh
air and tells it as it is! Taleb either
states the obvious or makes generalizations to the point of ludicrousness! Either way, people were
quite breathless.
The book is accessible. What a
double-edged sword that is. It brings
with it the consequence that anyone
literate in any of the 17 languages it
has been published in feels able to
formulate an objective opinion on
it. Because its all about dumb luck,
isnt it? It leaves you with the conclusion that modern finance has gone
long on snake oil. Boo hoo! The other
conclusion that we draw is that its
all just so much noise. Calm down!
So, the Cambridge Union invites
Taleb to debate, given the exact wording of the proposition its barely

worth discussing any further. And

the final count? Abstention was the
order of the day; a protest against
globalization. Go figure.
Taleb takes a hammer to the liberty bell. This is an enjoyable spectator sport. He desecrates the bell curve
and the entire business of statistical
inference; the sanctum sanctorum of
the priesthood of modern orthodox
finance. Who do we see turning
the tables outside the temple? Your
understanding of randomness is
wrong! The Gaussian only fits with
non-scalable, usually physical phenomena. And it goes deeper than
that. The reverberation from that big
ding-dong shakes us to the foundations of modern finance.
In his latest essay, The Black Swan,
Taleb takes us on a trip to the lands
of Mediocristan and Leptokristan,
but at the heart of darkness he finds
Plato, or at least the band of Dennis
Hoppers he inspired.
You will recall from your brush
with philosophy that Plato had a

The problem is that we are all

Platonists, we automatically look
towards an ideal state, one that
makes sense (always in hindsight)
32

Taleb (with Espen Haug, and Benoit Mandelbrot) on Mandelbrot: I will ght to the
end to promote his method as a framework to look at deviations

thing about pure forms. As a lover of

wisdom, a philosopher, one should
turn away from the distraction
that is the empirical world. In the
empirical world we only see particular cases of a universal, the beauty
of a woman or that of a statue of a
woman are instances of a universal
beauty, our reference in physical aesthetics. We have an understanding
of beauty prior to our reference to
it in a particular case. Furthermore
we are able to qualify comparatively
between two objects we find beautiful the Platonic argument is that
things in the physical world are
all compounds of various qualities
which do not in themselves exhibit
perfect beauty but tend towards
an ideal beauty to some degree.
Therefore, since we have a sense of
what beauty is prior to applying
it to a particular object, and we are
able to discern between the levels
of beauty inherent in two objects
then there must be an a priori beauty
which we have an understanding of
in order to make that aesthetic judgment in the particular case. In order
to make a classification there must
be a universal class under which

these objects would be subsumed.

The problem is that we are all
Platonists, we automatically look
towards an ideal state, one that
makes sense (always in hindsight),
one that ignores the aberrations,
the one that can stand up with us
when we sing the national anthem
of Mediocristan.
Mediocristan, Taleb explains, is
the land of the bell curve. That is,
no doubt, what they have embossed
on their license plates there. This
place is a province dominated by the
mediocre, with few extreme successes or failures. No single observation
can meaningfully affect the aggregate. So human height is a perfect
example, because out of a sample
of 1,000 people, even if one person
were twenty feet tall it would make
no impact whatsoever on that comforting undulation. Randomness
here is mild.
Leptokristan displays a wild
randomness, a province where
the total is impacted by a single
observation. So here you will find
the distribution curve for, lets say,
personal wealth of 1,000 people, and
one of them happens to be Bill Gates.
Wilmott magazine

TALES OF THE UNEXPECTED

Platonicity Glossary
Nassim Nicholas Taleb provides a
brief guide to his key themes
Platonicity: the focus on those pure, well-defined, and
easily discernible, objects, like triangles, or more social
notions, like friendship or love at the cost of ignoring
those objects of seemingly messier and less tractable
structures.
Nerd knowledge: the belief and custom that what cannot be Platonized and studied does not exist at all, or is
not worth considering. There even exists a form of skepticism practiced by the nerd.
Ludic fallacy (or uncertainty of the nerd):
Manifestation of the Platonic fallacy in the study of uncertainty; basing studies of chance on the narrow world of
games and dice. Aplatonic randomness has an additional
layer of uncertainty concerning the rules.
Epistemic arrogance: Take a measure of the difference
between what someone actually knows and how much he
thinks he knows. An excess will imply arrogance, a deficit
humility. An epistemocrat is someone of epistemic humility, who holds his own knowledge in greatest suspicion.
Epistemic libertarian: Someone (like myself) who considers that knowledge is subjected to strict rules, but not
institutional authority as the interests of organized knowledge is self-perpetuation, not necessarily truth (just like
governments).
Narrative fallacy: our need to fit a story, or pattern to

There is scalability here, and the ride

can be much, much more volatile.
Deviations from the mean are not
exponential.
Taleb introduces us to the Ludic
Fallacy, he asks us to stop talking
about casinos and games when
we want to discuss uncertainty.
Why? Well, more of that in the
interview, but suffice to say its
because the house always wins.
The Leptokristan /Bell Curve gap
is a simple application of this Ludic
Fallacy. Taleb says, but dont get
him wrong.My problem is noncomputable odds, whether bell-curve or
scalable. It is just that I prefer the
Wilmott magazine

series of connected or disconnected facts. The statistical

application is data mining.
Narrative discipline: discipline that consists in fitting a
convincing and well-sounding story to the past. Opposed
to experimental discipline.
Platonic confirmation: You look for instances that confirm your construction (or model) and find them.
Platonic fold: The place where our Platonic representation enters in contact with reality and you can see the
side-effect of models.
Scandal of prediction: the poor prediction record in
some forecasting entities (particularly narrative disciplines) mixed with verbose commentary and lack of awareness of their own dire past record.
Epistemic opacity: Randomness is the result of incomplete information at some layer. It is functionally indistinguishable from true or physical randomness.
Black-Swan blindness: underestimation of the role of
the Black Swan, and occasional overestimation of some
specific one.
Round-trip fallacy: the confusion of absence of evidence of Black Swans (or something else) for evidence
of absence of Black Swans (or something else). It affects
statisticians and other people who lost part of their reasoning by solving too many equations.
Fallacy of silent evidence looking at history, we do not
see the full story, only the rosier parts of the process.
Future blindness: Our natural inability to take into
account the properties of the future like autism does not
allow the patient to take into account the existence of the

scalable as a statistical paradigm.

The epistemological grounding of finance the ory is unsound.
Because just as men are from Mars
and women are from Venus finance
is from Leptokristan and mundane
matters such as distributions of
height, weight and calorie consumption are from Mediokristan.
In a way there are a lot of people on
Wall Street or in the city of London
who go to work every day in drag.
You have often read the following
words: Assuming a Black-Scholes
world We believe we operate in
Mediocristan but in fact it is the
wild shores of Leptokristan upon

minds of others.
Circularity of Statistics (the statistical regress
Argument): We need data to discover a probability distribution. How do we know if we have enough data? From
the probability distribution. If it is a Gaussian, then a few
points will suffice. How do you know it is a Gaussian? from
the data. So we need the data to tell us what is the probability distribution, and a probability distribution to tell
us how much data we need. This causes a severe regress
argument.
Scorn of the abstract: Favoring contextualized thinking
over more abstract matters. The death of one child is a
tragedy; the death of a million is a statistic.
Retrospective distortion: Examining past events without adjusting for the forward passage of time. leads to illusion of posterior predictability.
Mediocristan: province dominated by the mediocre, with
few extreme successes or failures. No single observation
can meaningfully affect the aggregate.
Leptokristan: province where the total is impacted by a
single observation.
Black Swan ethical problem: asymmetry between the
rewards of those who prevent compared to those who
cure.
Problem of induction: Logical-philosophical extension
of the Black Swan Problem
Bell curve (Gaussian): or GIF, great intellectual fraud.
Application of the ludic fallacy to randomness. There is
a qualitative difference between Gaussians and scalable
laws, much like gas and water.

which we have been washed up. If we

lived in a Black-Scholes world, LTCM
would not have happened.
This was a viewpoint that many
experienced traders did not find
difficult to accept when Taleb first
developed it in Fooled by Randomness.
The Black Swan is not about finance,
it is about the philosophy of history.
But it carries the same warning.
Wherever you encounter people
saying something is statistically significant, its a sure bet that they have
looked at their observation errors
and assumed the big bouncy bell
curve is in play. But the way that we
interpret those samples? We ignore

the unseen, the unknown and the

unexpected. Recall Taleb at the end
of Fooled By Randomness, watching
Odysseus battle the pull of the
sirens song, and taking away the
lesson that one should not attempt
to emulate the man tied to the
mast, but accept that at best we
could hope to plug our ears with
wax and live with randomitis. Here
in the Black Swan we are at sea once
more, Diagoras, when shown the
offerings made to the gods by those
who survived their sea voyages
asked, what about the offerings
made by those now in the bosom
of the briny deep?

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TALES OF THE UNEXPECTED

Nassim Nicholas Taleb:

He desecrates the bell
curve and the entire
business of statistical
inference

34

Wilmott magazine

TALES OF THE UNEXPECTED

Standing at the Platonic Fold

Nassim Nicholas Taleb brings us up to date on
the thinking that is behind The Black Swan

just finished the first draft of

the Black Swan spent a year
hiding in cafs and libraries
working on it. I wanted to get
closer to my idea of a pure epistemologist, get rid of what trading
was still hampering me, going deeper into matters, as deep as I could.
But unfortunately I am now back...
(laughing).
How did you use quant finance as a
base towards philosophy?
NNT Quant finance proved to be a
wonderful place to learn the stuff, a
place to generalize because you can
see the explosive Platonic fold,
where reality enters in contact with
what mental representation we have
of it, where things are uncharted
but people are deceiving themselves
with constructions and calling them
science. It is better to start with
markets than the other way around.
Many people study, say, physics,
mathematics, probability, or psychology to try to understand finance.
Then they show you that superimposing these ideas works beautifully. A few might get rich for some
random reason, and then we impart
their success to their understanding
of psychology or socio-politics. So
people come to finance blinded by
some idea, looking for and finding
confirmation. I think that because
of the messy nature of knowledge
we have in finance, it is much preferable to go the other way around. We
learn to think in an aplatonic way

Wilmott magazine

away from what I call Platonicity.

Now I climbed up to the mother
of all the problems, the generator
of Fooled by Randomness. It was also
the problem with my earlier work
Dynamic Hedging where I examined
the contact between theory and reality. Platonicity is the generator of
these problems.
Can you explain Platonicity?
It is the focus on those pure and
well-defined, and easily discernible,
objects, whether triangles, or more
social notions, like friendship or love
at the cost of ignoring those objects
of seemingly messier and less tractable structures. Seeing patterns is a
form of Platonicity as we refuse the
mess of randomness. This is also the
product of our need for reduction
we need to reduce, and Platonicity
has side effects.
Can you give us an example?
Take a look at a schoolworm picking
up a new language. He will learn, say,
Serbo-Croatian or !Kung by reading
a grammar book cover to cover, and
memorizing rules; he will operate
under the impression that some
higher-up grammatical authority set
the linguistic regulations so that nonlearned ordinary people could subsequently speak the language. In reality,
grammar is something that comes
after language, just as in any form of
scientific model. It is something people without anything more exciting to
do in their lives codify into a book.

While the scholastic-minded

will memorize declensions, the
aplatonic non-nerd will acquire, say,
Serbo-Croatian by picking up potential
girlfriends in bars on the outskirts of
Sarajevo, or talking to cab drivers, then
fitting (if needed) grammatical rules.
The same applies to science. It can
be generalized to the manner that
some people have a personal inclination to dip into textbooks while others pick up their knowledge on the
streets (there may be a few rare combinations). Consider the economic
planner. As with language, there is
no grammatical authority codifying
the economy; but try to convince one
of those economists that the world
might not want to follow his scientific equations. Indeed Austrian economists used the notion tacit knowledge, about economic matters,
precisely for that part of knowledge
that precisely cannot be codified, but
that we should avoid repressing. It
just comes out on its own.
I learned from looking at finance
professors with some model taking
possession of their head. But the best
manifestation of Platonicity is with
the ludic fallacy
The Ludic Fallacy?
We are basing studies of chance on
the narrow world of games and dice.
Aplatonic randomness has an additional layer of uncertainty concerning the rules themselves.
I called Ludic fallacy (after the
latin ludus, play) the misuse of
games as the wrong epistemological ground. Let me show here how
randomness ends up disappearing in
these games. Just consider that you
know the probability, and that the

payoff does not change throughout.

The casino never surprises you by
announcing that it will be paying
you 100 times more, or a tenth of
your take. Furthermore, the dice
average out so quickly that I can say
with certainty that the casino will
beat me in the very near long run at,
say, roulette, as the noise will cancel
out though not the skills (here, the
casinos advantage). The more you
extend the period (or reduce the size
of the bets) the more randomness,
by virtue of averaging, drops out of
these gambling constructs.
Alas, we suffer from the general
tendency by those who put their
noses too much into maps to mistake
the map for the territory. Go buy a
history of probability and probabilistic thinking: you will be showered
with a series of names you see recurring in all these books, like Cardano,
Pascal, Fermat, Huygens, De Moivre,
Laplace, Gauss, De Finetti, or
Kolmogorov.
Contrary to what we were taught
in all these probability volumes,
and in the misguided books on the
history of probability and risk,
gambling could not offer us lessons
about real randomness, nor can it
be a laboratory where you could get
actual training for the messy real
life. As just as we tend to underestimate the role of chance in life in
general, we tend to overestimate it
in these games. It is the only place I
know where we have mild Gaussianstyle randomness!
Furthermore I found it infuriating to listen to people who, upon
being informed that I specialize in
problems of Chance, immediately
jump to references to the dice.
The ludic fallacy is present in the
following chance setups: random
walk, dice throwing, coin tosses, the
infamous digital heads or tails

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TALES OF THE UNEXPECTED

The aplatonic non-nerd will acquire, say,

Serbo-Croatian by picking up potential girlfriends
in bars on the outskirts of Sarajevo
expressed into 0 or 1, the Brownian
motion corresponding to the movement of pollen particles in water, and
similar examples. These generate a
quality of randomness that cannot be
even qualified of randomness protorandomness is a more appropriate
designation. At the core, all these
theories ignore a layer of uncertainty.
Worse, they do not know it!
And the ludic fallacy leads to
the Gaussian, the Great Intellectual
Fraud, GIF.
Beware the Gaussian?
The ludic fallacy leads to the use of
that monstrosity called the Gaussian
and its siblings. And fixing it is not
easy. The problem is that you
cannot naively fatten the tails: you
are in a situation of uncertainty
about the distribution. NonGaussian
randomness generally implies
that you do not know much
about the tails.
Consider the following. We need
data to discover a probability distribution. How do we know if we have
enough data? From the probability
distribution. If it is a Gaussian,
then a few points will suffice and
we know how many. How do you
know it is a Gaussian? from the
data. So we need the data to tell us
what is the probability distribution,
and a probability distribution to
tell us how much data we need. This
causes a severe regress argument.
The other one is to start ranking
results based on their dependence
on models.

36

Platonicity has an important

extension: categorization.

Categories?
We need to extend our uncertainty
to categories because categories are
fuzzier than we think and we tend to
want to see crisp boundaries. There
are many things we cannot separate
because they cannot be isolated. For
instance, utility and probability cannot be dissociated.
Wilmott magazine is a second
home for me, simply because I found
credible like-minded people and
social friends who can either agree
with me, say Haug, or heavily disagree, like Elie Ayache. Ayache by challenging my ideas has taught me a lot.
He is the only critic I have felt compelled to answer. The others dont tell
me anything I didnt think about.
Ayache argues that it is the philosophical foundation that needs to be
overhauled in order that quantitative finance can be recognized as a
science. That to accept your combination of skepticism and classical
empiricism leads in two directions
only, blind faith or skeptical resignation. He proposes to find a third way
through a rethinking of what a market actually is. What is your reaction
to Ayaches metaphysical interpretation of derivatives as being the path
toward this new approach?
This is where I disagree. The skeptic
in me is easily satisfied by my ranking situations in accordance to their
robustness to model error, or their

Platonicity. For instance a portfolio

that depends on tail probabilities is
much less robust than a long-only
venture capital investment or a long
out-of-the-money calls. An arbitrage
with cash and carry is more robust
than a probabilistic one. You can
generalize into soft and hard knowledge in real life, outside of finance.
As to metaphysics, I will leave it
for another discussion. My branch
of philosophy is that of statistical
inference, a supervision of scientific
claims, nothing abstract. But I agree
that we can escape problems by
rephrasing them, except that I do
not want to escape these problems.
I am both a radical skeptic and an
empiricist and I do not find the two
incompatible at all. The school of
empirical medicine in the second
and third centuries was grounded in
radical skepticism.
The real divorce for me is between
aplatonic view of the world and aesthetics. I want the world to be more
aesthetic yet I want to acknowledge
that it is considerably less so than we
think or not where we think.
On the basis that our sampling is
wrong to start with when it comes
to assessing the value of a given
approach to trading and investment,
and that our programming doesnt
allow us to (easily) accommodate
black swans prior to the fact it is
highly unlikely that a shift is going to
occur in finance toward the basis in
skeptical empiricism that you represent. Do you agree with this?

Finance is moving very quickly into

firmer grounds. People know of the
severe Nobel side effects and pseudoknowledge. We already know that
much of portfolio theory and modern
finance provide negative knowledge
because of their side effects, that
many hedge fund managers have
LTCM-style cosmetic alpha.
The next LTCM-style blowup will
help a lot.

Can you say something about how

an approach like Mandelbrots
would disabuse the market of this
dependency on the Gaussian?
Mandelbrot changed geometry. He
will change much of social science
his model starts with the tails as a
central element, not some appendage. It is a completely different way
of thinking if you are going to be
Platonic, this is the way to do it. I will
fight to the end to promote his method as a framework to look at deviations. He is the only person who ever
understood what I was saying.
Can you envisage a time when
trading and investment in general
takes a more realistic view on outliers and how to incorporate them
into models? If this occurs what will
the markets look like, wont this cut
out so much noise that sustains the
industry? In such a world without
the GIF holding sway will everyone
be able to go home at the end of the
day less anxious because markets
have become less volatile as a result?
I do not know what it would do to
markets. But one day we will understand the toxic side of beliefs (and
models). One day we will understand
Shackles point that economics and
human affairs are about epistemics,
the study of unknowledge. It will make
the world a better, and certainly safer,
place. Ciao.
Wilmott magazine