Nassim Taleb at the 2018 Prime Quadrant Conference

ladies and gentlemen welcome to the stage mr. Nassim Taleb [Applause] so just to start off we you know Nasim you actually have some prepared remarks I'd love for you to kick it off and then we'll continue the conversation yes I mean it's not that they're not remarks by the way the much less remarks and pictures are going to show so I just wrote a book called skin in the game which is volume 5 of collection called incircle and it takes a while to figure out what you're writing what your subject is you know vaguely the details and same start to sort of like mix together to provide a little more unity so it took me a long time and now I figured out what it was that I was writing about the past 20 years she I started life as a trader I was a trader then I started doing that kind of stuff see so I didn't start like by don't theories I'm going to practice and I noticed that when you start with practice and then start figuring out the theory that about 90% of the theories you know are nonsense and something are useful but then that process of going from practice to theory is very different from the one that people have you know easily don't for theories they study and then they apply and of course they were supply and there's the other so I became progressively a I start retiring and to this or also but by doing mathematics of risk mostly mainly because lack of other hobbies or incompetence and other hobbies like I'm not very confident at tennis not competent at chess I lose concentration I wish annoys the person playing with some so I have to spend my days doing this start discovering some stuff it's the first thing I discovered is that without skin in the game this is what happens to a profession skin in the game is really when you have something at risk in any situation so you learn and also it's the filtering so I'm not gonna talk about skin again with one of its consequences what is it that we don't quite that about probability and stuff like that so the first thing I'm going to talk about is fat tails fat tails was a subject fat there's or not tails sale for animals that's describe it in a few minutes what's the difference it's sort of the subject of the Black Swan by saying practically everything you study in statistics at school is useless for the domain I call extremists and as a matter of fact every single inclusion you build that school would not work and let's see how say as I pick randomly to people and this car is called a catastrophe principle I take randomly two people from the population randomly and I measure them and I have a very unlikely sample of a total height of 4.1 what's the most likely combination 10 centimeters and 4 meters didn't ever see which things in Canada okay what's it gonna be 150 and 260 no 2 and 2 2 2 or 5 2 or 5 so Frank so in that domain called video post and if you have a bad year it's not gonna come from one birthday you got to come from two events as unlikely it's much more likely to have 2 x 3 Sigma events then 1 times Sigma or 2 times 5 Sigma less than one time times Sigma and that by definition tells us what a Gaussian is what the domain is and that no extreme can really blow you up if you diversify the portfolio theory is based on that you're not going to have if you have a head it's not one stalk it's a combination of stocks if you have one mishap and not one combination of thing Six Sigma all that fails because I'm going to give you you know that have high net worth individual lesson by now 18 the 36 million is nothing that was anyone for fun now start to get inflation yes it's real money I selected randomly two people from the and I happened to have a very real sample that has a total wealth of 36 million that's the most likely combination 18 and 18 what is it thirty five point eight even better I'll tell you if you take this on a planet thirty five point nine nine five one has like two hundred dollars or net worth and the other has the balance so it tells us that in domains it's not financed if you're gonna have a hit it's gonna come once not a series of elements it's more likely to come not then Sigma in the market is vastly more likely than two times five Sigma effective now we understand that the ruin you have to be a lot more paranoid and thinking about it does not think of changing the color of a dress not saying oh we're gonna apply this it is fundamentally constructing portfolios differently doing things differently and for example people don't quite get it when they Ebola is from experience and if I hear Ebola has killed maybe at some point someone made a joke that more people transited more American citizens transited through the bed of Kim Kardashian here we have Ebola then died of Ebola many people we have look smoking 450,000 sois us-centric alcohol six thousand people we gotta worry about these no because if you go to Mars you guys have like places and kind of a very similar way okay you go spend two years and on the way out they tell you well the death toll on a planet was about a billionaire once you like it come from smoking or Ebola condition wanna tell events odds are gonna come from that multiplicative process that can cause these things that's the fat tail this is why you have to worry about ruin coming from these things that are very fat tail and financial markets are fat-tailed so that's sort of like my you know ideas 101 now let me give you some comfort to it thanks here I have a few contractors point until a few people are getting sleepy you know tired of these kind of tools points will engage in conversation your risk profile is not average the consequence is that very simply not one person here no matter how hard you try with your own money or your funds money or your clients money or your grandmother's money nobody here will get the returns of the market okay simple you don't may get more oh my god let's go on forward let's see how why because you see how many Americans walk down the aisle thinking that this is permanence or permanent status and and and for them it turns out to not be permanent divorce fifty percent rate so and and I'm sure they're not like viciously getting married knowing the very okay so what do you engage in a portfolio you may want to get out you may change your allocation something may happen you may be forced to reduce your risk forced odds are you'll be forced to reduce seriously what happened then decouple from the market which is why you can't get the market but there's something even more vicious now we're going to talk about here called past dependence I don't know how the experiment has never been tried in Canada as a formal scientific experiments rigorously but has been tried in other places and let me report if you wash your clothes first and iron them later second you get a different result or if you iron your clothes first and then washing later agree that the sequence matters so taking this sequence something quite trivial if you want to get rich to succeed one of you must first survive it's not like survival you see it's not like and separated like have the risk management group on a nice floor and the traders on the twelfth floor okay it's the same function you must survive and as a matter of fact risk is just arrival I remember when I started trading and there you know and all traders called me Hamptons Ward and you get all kind of abuse by all traders who want to teach you life because they're bored okay and you have to listen because you know but the fellow said something quite interesting that stayed with me he said take all the risk you can conditional or he said but make sure you're in tomorrow so you have to separate ruin from regular speaking so let's see how the completely different animals let's say and why and another reason the return will never be those of the market I seriously apologize for the crudity of this it's my book because I do myself and as you can see I'm not gifted I can draw but I insisted on a publisher keeping it and a book rather than bring me sounds so you know Illustrated so that's all experiment you have enough people here there is a new casino in Toronto and we have no idea what the Alpha from the casino is no idea we know it steady its you know run by rigorous people will hang over the alpha is negative positive have no idea sometimes you know casinos give you a positive answer with blackjack and stuff so the whole room say about how many people or how many people here because other people have something else to do you go to the casino each with an allowance gamble for eight hours and come back and you tell the everything you sum up all the returns divided by everything we started with and you got a total okay now if you add zero in addition doesn't have a big impact no it dilutes by one over n the number of people nothing so and it's number 28 gambler goes bust or as we say in tapioca all right does number 29 care no may even so simply people this is called horizontal probability everything in finance is done that way you compute the cost benefit analysis by summing up probabilities by options but there's a flaw and they see how the flow is if any one of us here instead went to the casino for a hundred days how many people for one day one person four hundred days and started gambling and on day 28 she or he went bust tapioca will they be day 29 no so regardless of the alpha of the casino once you hit ruin your you're gone no this is not trivial okay why that's not review it changes the way you got to do everything this incidentally is a cartoon about that topic by the I hate the cartoonists okay here's a cartoonist so who discovered that this fellow on right is Murray gell-mann and fellow on the left Peters both physicist Gilman you may know him Nobel Prize in Physics he's not to have a huge ego I mean I'm sure this room will be too small for a very good mom you know and he bullied freed Fineman he started the Santa Fe Institute if you have an American lineage that we have okay Peter Gilman the way we compute probabilities in decision science and finance and young man said this is BS because there are concepts they call it their velocity in something you cannot take a static analysis and apply dynamically because dynamically you return your average return is multiplicative so if you multiply by zero from what I'm told absolutely tolls in Canada although again I mean I haven't seen the evidence here if you multiply something by zero or the focal is zero no that typically holds a lot of place even class it doesn't change okay so and I lose the return so when you're in other words if you're absorbed if you have an uncle point you're gone so focus you know getting the average return is absolutely of no help to you and the return of every investor are gonna diverge over time the average locals will get the market but I think something like only 10 percent should get above the market somewhere in this room if you're invested in the market okay this is very very very okay you had the problem is absorbing various matter some people understand it to some industries they want zero blower zero probability of not surviving now there's came from New York using one of those and if the error rate is 0.1% I don't know if it'd be many pilots alive because over four year career as a pilot in law so taking the average is significantly the way I phrased it is [Music] when I was a trader said crossing a river that is three feet deep on average okay isn't something she's consider all right so the point is so if you have second-order flight risk it was already right now this is so trivial every single trader knows it and no academic that I know knows it so it's like having two parallel universe okay every sailor knows it okay if you have a tail risk you're gonna go bust every individual now Goldman Sachs the men in existence 449 years we sort of all Haven that might okay they may have had support by the US government last ten years nine years maybe but still we have a hundred forty years and these people do a lot of trades and they have a lot of us it means that these people have survived to have close to zero probability growing up I got up and down and and effectively every trader I know treats probability absorption differently from alpha and return and all that stuff because it's something very simple if I have a tiny probability of ruin them I would be one it's not like an option tiny pearl over time your Knights at the time so the way people look at risk is wrong the way you've got to look at risk is if you're gonna do this for the rest of your life by how much is it gonna shorten your life expectancy okay that's the way to do it you see or what's your expected life expectancy if you do this if you had infinite lives and you smoke you know if I can see would be something like on average 60 all right it would lessen by twenty four years shortened by twenty four years so that is the problem that's not in literature if I'm gonna take some tailor risk okay how long can I do that before I'm caught you know by the market it's a way to do it but you see what I'm discovering and I insist in my book that grandmother understand that our grandmothers know that risk professionals don't the way they they they do the cost-benefit analysis is as if you're never going to take more risk in what but the problem is if I if I play Russian roulette and succeed what am I going to do play again so it's not like I have twenty percent chance of dying it's okay Russian roulette I have a hundred percent Frances I am the repetition if you succeed you play again the same with smoking well your mi smoking any cigarette no cigarettes gonna kill you okay not that I enjoy it but I'll say you know okay so you take one cigarette but show me someone who enjoyed one cigarette and that was it for the rest of the remaining balance of his or her life you see you got a look at it so when you engage in risky activity whether a banking institution or anything or selling options you don't have the same power at some point it's going to catch up with you so the problem and now there are ways to play the game and avoid ruin who discovered that someone no zero Kelly criterion Kelly Kelly at torque of the gamblers and you had a gambler here a charming person and all these people understand ruins just like traders understand ruin those who do things with our hands for a living so they fellow she's got the nobel rooster sailor or novella or pseudo nobody the bank of Sweden prize and honor that Nobel okay but the course Nobel for showing us that is irrational to do what you should be doing at a casino and let me explain when people who are smart know to survive engage in any form of risk-taking they tend to play with the houses money okay the play actually even a theorem is there is a book how I was a doctoral thesis of a famous statistician how to gamble a few must and if you cannot imagine the abuse they got on Amazon by gamblers who thought it was a gambling work but it tells you the following the only way you can survive in gambling and not hit the barrier is to enter the casino say you have a thousand dollars Canadian okay okay thousand dollars you bet if you make money what you do you bet more as you get close to your uncle point you reduce your meds and in fact if you have the alpha you can get your alpha that way and continue indefinitely that there's a slight that alpha and a casino you will get it by shrinking on losses preemptively not sure you know smoothly shrinking and and adding as you making money so it's called playing with house money now these behavioral finance people find it irrational why not because they've never better to see know that I'm sure that they didn't think about it dynamically they think it's irrational to take more risk with money if it's partly the casinos money then your own your initial endowment and to go back to a few points they also find it very very illogical to be paranoid okay so do you like being paranoid not terribly sorry not terribly no okay but nobody like to be paranoid but think about it if we as a human race war paranoid that have these paranoia and conspiracies immediately springing okay even if they're wrong 99% of the time we would do we be now extinct you have what you'd have some nice trees here and where we are in this building is has all these environmental problem will disappear we wouldn't exist as a race we exist only because we're paranoid because if you analyze dynamically the payoff from paranoia is huge likely to cigarette if you are paranoid about cigarette I don't smoke once it's irrational psychologists will tell you you got to be paranoid and how could be structurally paranoid no Taylor is take all the stuff you want people do that in their lives I don't want to know this show me a person who buys a house without it without insurance ok show me a person I mean you in some places you're allowed to do that I don't know how paternalistic the true those are here for sure whether they force you but that you typically it have to okay so show me a person who you know you're overpaying for the insurance you can't buy the house without the insurance because you can't afford that ruin and what comes out of it so the so that's the first point I guess and we can go from here we can go from here and so let me keep the paranoia on let me come back to the book because it's a fascinating read and you know anybody that's engaged in taking risk is familiar with the surface notion of skin in the game what could you talk a little bit about some of the unintended consequences of skin in the game and the way that it manifests itself okay this bicycle game I mean thou shalt not transfer your risk to society okay while having the benefits and some disguise the way you see but there's one aspect of skin in the game that's linked to this a friend of mine a former goldman partner retired and unlike me he didn't do math so he decided to lose his money slowly in the restaurant business so that's the way you know you wanna lose the money slowly but surely that's the place to be so he invested in his restaurants and then he noticed that business is weird first of all I mean so like if you ever been to there's ways to divide to charity and help a lot of people rather than open the restaurant but you know it's one thing there are Awards of that business so orange now the best atmosphere was sushi the best atmosphere was absolutely their kind of awards and all kind of specialties then there's a gala the restaurant that got the awards did make it to the gala why because who gives the awards it's not the clients you want to press your clients not your peers it's other restaurant owners so areas that have expertise are defined very simply by people have skin in the game in a sense a plumber his PML okay it's not determined by what other plumbers think of him okay he doesn't care about impressing other plumbers he wants to impress his accountant these survive and also there's no BS unless but academics who judges academics other academic other academics so therefore you can have as we have in financial economics and economics microeconomics people completely out of sync with reality and we'll never know because there's no but a pilot of a plane all these people they're in sync with reality because those who are now guess what where are they pilots were none sequence reality where are they at the bottom of you know near you know when somewhere north of Vancouver in the middle of the ocean okay so that's what so they are filled so this is the idea of surrender game is that any knowledge we got about anything that doesn't come from professionals who have survived is by definition tainted we will have a flaw somewhere and you got to find that flaw that's my idea in the game of course you have ethics you know go faster your risks if you own your own risks you see you have skin in the game you will survive if you're right if you're not right you exit the pool and there will be no side effect of that that's the idea of game so coming back you talk in the book about this concept of the rule of the minority and the fact that the minorities impose a cost on the majorities so maybe if you could just outline the concept and perhaps comment on where in the financial world the minority imposes a massive cost on the majority okay okay so my book is about two effects one when you put dynamics the other one wanna put scale so scale in other words if I know how each one of you behaves and I add up every one that's what it doesn't help me predict how the problem and how did I discover that I was trying to define complex systems at a party at the complex system Institute and a few people from Jerusalem came and they were religious and I felt embarrassed because I was co-organizer and we didn't have kosher drinks I don't think about it I'm so sorry I didn't know you were coming and so on yeah relax relax what all drinks here our culture what yeah look at the bottom oh okay so like material no I mean speaking pros all these years I've been drinking course your drinks knowing point three percent of u.s. population is kosher but let's say you're coca-cola or a manufacturer what do you want to do have a kosher truck push for this go through that and then have an aisle and have shipments what do you do you're making more kosher if the cost is small so someone coming from Mars and studying the food habits of the US population it would be mistaken from the food habits to believe that or from a drinking habit the majority is cultural effect point three percent okay so that is almost all very cool ok so started looking into the matter right there as the complex is you know and it's a complexity subject in the sense that how a collective behave differently from the individual part of the collective so started studying how you can enhance situation like that I was on American Airlines no peanuts why all you need is one person on the plane to the allergic to peanuts for no peanuts so so you realize that minorities are effectively driving our habits in in and then I looked at marketing people don't quite understand the habits of consumers automatic cars you think that people would have a preference for optimizing car that's what we sell no stick shift is what people preferred at a time when it's still you know had them but if you family a four and one person doesn't watch the truth that's what the whole family will have the automatic so so we have these things now I'm going to Marcus start examining situation markets where the collective is different from individuals one of them from minority rule I realized and and there's very simple experiment the day when associative in Iran had thought had nine years ago they had a rogue trader okay they sold fifty billion dollars of stocks very quickly it was an unconditional say the minority ruled means someone who unconditionally would only drink quarter someone who's not whereas the rest of us don't mind doing both quarter-on-quarter there's no difference for me you see or at least small difference but bigger for him or her who's in the minority so I know that someone wants to sell 50 billion okay what happens we have the market is what is it now thirty trillion now what is it sorry more than fifteen seventy include just the the the stock markets yes it's related okay so drove markets in lower at a time that was a ton 133 million in 2009 those markets lower about twelve percent minority you see so you realize always someone willing to pay up for someone to sell down an auction until determines prices not the collective so from that we are we have the material can be very very dangerous because if you if you tell them and those who play in the minority rule and politics all you have to do is be intolerant and 98% his population will submit say but also works for ethics if you are a thief you don't mind eating non stolen merchandise no I mean I've never been see for I don't see I won't say it but a honest person will refuse so all you needs a minority of honest people for society to be honest so start looking at minority rule I noticed that whenever something is stable across societies it cannot come it cannot be a majority rule by definition majorities fluctuate it gotta be very potent the north zero whether in politics whether in Human Rights whether you think with Saudi Arabia now what happening in Saudi Arabia do you think because the majority people don't want to know Orion is the minority of people were intolerant and willing to save others say I would not do business with you I was not hired as an actor I will not play tennis with you if you you know help Saudi Arabia and suddenly have a spiral well there so one of the other cons have you talking about book Wichita was intriguing was the notion that the affluent are typically easier to exploit than the exploit than the non affluent how does that reconcile with the fact that I mean look at everybody in the room is a is sort of at or near the 0.1% and and these are typically savvy individuals that have built businesses how does the fact that there are what affluent are more easier to exploit reconcile with that I mean and that was Seneca who said that base is that if you're that you're much more likely to be a turkey of someone because more people will be you try to take their money if you're rich then if you're poor okay and and the examples I give are mostly for my private life is a few times I mean I like a good meal a good traditional Italian meal a reasonable price and sometimes you drive them to these torturous sessions and some three-star Michelin or you have to eat microscopic food and we concentrate so I told myself listen would I pay $300 for the pizza a good fresh pizza was fresh basil and fresh herbs if I had to choose between this mean for 795 or the pizza for 300 I think I'll pick I would pay 300 for a pizza these complicated meals so I realized often when you're rich you become target people who want to change your lifestyle so they can make more money off of you and and some people have long enough to fall and to do things because they think that's what they should be doing because they're rich in fact that's not optimal for them just like a lot of houses people are sad that a lot of houses because a lot of houses are empty devoid of human warmth so small little things like that and then a book that was assigned chapter that was that was that was only I mean if you're gonna if you engage what I wonder if people off the best way to do it is say oh the rich is much more exposed to being a ripped off than the poor let me close off our conversation with one last question you know you have again this is a investor conference everybody in the room to some extent is involved in investing how what recommendations which you have or what it would be your top recommendation for investors that want to utilize the lessons of skin in the game and antifragility and some of the other notions that you've spoken about in some apex simple role first decide instead of investing in medium risk security if you invest a medium rate security can you portfolio to zero it can but if you that's half of it'll have a very high risk securities and the other half and close to Norrish securities can you portfolio drop by more than half no so the whole idea is try to switch your risk preferences around with the same risk reference which your allocation around to have a part that you'll never lose and a part that you lose so in other words buying protection on a portfolio okay allows you to be much more risky to take much larger risk or the portion because you don't have ruined so which is what I call the barbell torso that's what it's everything falls on the same idea that you want to avoid the one and if you are going ruin and guess what then other people did not avoid their own that's where the money is made because if you can buy in 2008-2009 and other people are you know trying to watch TV or something because we strike themselves on the pain of opening the statements at the time was still on paper that then you have huge edge so that optionality comes from having extra cash for the crash or something like that for example people think that cash is no asset in fact it's very valuable asset if you know how to work with it so take a lot of risks very diversified high risk items coupled with Norris guidance the payoff is much more rational because it will never you never hit ruined for example the other one is make sure you play with the houses money okay the other one is make sure to never encounter an uncle point an outlaw point being in the army or when the only has to say about okay if you never want to have to liquidate you want to do the reverse you want to have enough of reserve to not have to liquidate and to watch other people are created for a smaller things like that yeah well the same thank you thank you for coming all this way to share your wisdom with us we really appreciate

Channel: Prime Quadrant

Views: 11,246

Rating: 4.9136691 out of 5

Keywords:

Id: QX3k-u9_PeA

Length: 39min 9sec (2349 seconds)

Published: Wed Apr 24 2019