Wednesday 18 July 2007

Black Swan and Hedge Funds

Trader-cum-philosopher Nassim Nicholas Taleb has been back to hedge fund business, according to a recent report by WSJ. This guy is well-know for this "black swan theory", which he defines as extreme, highly disruptive events that sent shockwaves through financial markets.(Because in the West, there is wide held belief that there are only white swans, until European explorers discovered the black swans that are native to Australia)
He criticised people for tending to overestimate their ability to prejudge or predict the future risk. On the contrary, the potentially devastating risks are often "outliers" that fall outside of people's radar. one example is the 9.11 attack on the United States, which was beyond everyone's wildest imagination.
Based on his awareness of the Black Swan events, he adopted an unusual trading strategy. He often bet on those which seem impossible to happen but will have overwhelming effects when taking place. The cost on such bet is always cheap. When the bet fails, he loses marginally, but when the bet wins, he gains marvelously. When the dotcom bubble burst, his fund was awash in money, while others performing poorly.
But there is risk to his black swan strategy as well, which flourish on the impossible mission. It is painful, since you lose one dollar every day before hitting the jackpot someday. The money loss on a daily basis is quite painful process for people who can't insist on. In financial market, patience is nothing but a luxury. So he admited:if I go three or four years without a big bang in the market, I start having battle fatigue. Then he turned to writing in ivory tower.
But he has now staged a comeback. Has he foreseen the Black Swan coming again?

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