Stanford Seminar - Entrepreneurial Thought Leaders: Nassim Taleb

so I'm going to be this lecture correspond of anti fragile so I've written a book that has different sections the principle one at the end is about ethics and there's one on optionality we're going to be talking about as innovation as optionality I have to explain one option is what innovation is all that then I get 45 minutes and then we can take questions but please during the Q&A out of respect for the other person don't make a lecture because it takes out time it takes time away from the other person wants to ask another question so the next 45 minutes I'm going to be reading from page 423 to page 485 is it'll kill you so of the book and and and and then you know you can ask questions okay so page 4 clintus okay I'll do something about that the year so let me tell you how it all started okay my sort of will be a little biographical because can two separate I can't separate okay it's not can you raise the mike rinder is the volume or is there someone there or Oh a drop water on my computer so can someone have a oh it has we made this disrupt collection all right this is okay we're going to be discussing fragility all right I'm going to be discussing fragility I think my all right oh thanks so thanks for it's still working but I think it's working on its own thanks to the water but I think Apple is what about a few miles down the road okay okay so let me give you my sort of biographical story and my obsession with what I call fat tails to explain fat tails what you have here is the performance of an option portfolio the variation in price of an option portfolio daily variation over 57 years okay so out of the money options options that are remote is about 10 to 12 thousand days something like that 14 thousand days and as you can see there's a big spike for that portfolio that day represents depends on what you've been doing between 80 and 99 percent of your total lifetime variation if you're an option trader one day in your life should represent 98 percent of the variation if you are involve in remote payoffs this in other words is what I call fat tails and this is of course if you don't get that day right you're not going to get anything right and and and it's not predictable okay they tell you it's predictable if you go to the finance building they think is predictable if you got economics building that convinced is predictable it is not predictable so that's the problem is that they are events that have a huge impact and we can't tell at a time when they're going to come and we have no idea about their structure and put people fool themselves thinking they have no idea about a structure so you have to understand what domains are affected by these large deviations and also I don't know if your one hears from Brooklyn but in Brooklyn they say that you should make lemonade every time someone gives you a lemon so you got to make lemonade out of it so this is the idea that we have there's a huge amount of these events the rare event representing a large share of the pie now you live here at the epicenter of rare events okay Google represent this spike in its own business all right Microsoft on Microsoft was Microsoft it's still Microsoft but you know what is even more Microsoft than this today there was 50,000 computer companies and it had more than half the sales in that segment ok if you take the stock market over the past hundred years a lot of company joined a lot of company left there are about 12,000 surviving companies that are listed are these 12,000 companies how many companies represent half the capitalization what do you think sorry well when I was trading some some years was 50 to 100 some years was 300 to 400 there's no structure ok another example for example is a book business I don't know if you know about the book business there are million manuscripts in the English language on the market today by people who call themselves writers but typically they were in the u.s. they work for Starbucks and in Europe they they do other things they work for the government so they call themselves writers their novels are the million novels literary novels about 20,000 will be published of these half the sales will come from how many books sorry 20% no between 5 and 15 some years less than 5 it's not 20% it's very really we are in what I call extreme stat so let me give you an idea of what is extremists an if I can figure out how to work this computer if you imagine that you have convention here and you bring in a random selection of people from the planet a thousand people bring them to Stanford nice weather you know great way to convince people to come and put it on scale all right you weigh them you add to that sample the heaviest person you can find on the planet who can still be called a person how much of the total with that person represent sorry okay so say three times the average as we say in finance 30 basis points alright point three percent and if you move from a thousand to ten thousand how many how much will that person represent nothing three basis points okay so the maximum you can get will affect your average very little this is commonly known as the law of what large numbers about everything you do the statistical basis based on that law that as your sample becomes larger no deviation is going to mess up things for you agree if you eat you know I eat I don't know I consume eight hundred thousand calories a year not a single day is going to make me you know double my my phone my my weight all right thank God but unfortunately not a single day would make me lose half my weight unless you know I have surgery alright so the problem is that but then finance can you lose half your fortune in one day of course when I became a potrait ER there's a walk then there's something called new-member a badge means rookie so you get abuse by old traders were bored want to give someone life advice for life so they grab you so one guy grab hick come over here kiddo he said okay I showed up he said that was before this event incidentally he said listen you see the guy over there said yes he said his name is Edie yes he said at a time was a lot of money he made seven million in seven years said yes he lost them all in seven seconds okay said good dough now you can go all right that was his advice that you can you know that you're an extremist an the reasoning is different so everything is moved by extremes in economic life and visibly you're here for that to understand that point and we're going to take it to its conclusion so the first visibly it leads to unpredictability if I know how to I think that the water has done the damage I think the water has done it because I lost control over the mouse see the mouse doesn't want to move this is what happens when you take risks in life sorry I'm going do this sorry it's someone here an expert on yes to the rescue opposite presenters you hold on harm is out of you okay so this leads to what I call a predictability there kill you open intelligence we can do this no no the point is that okay this leads to unpredictability and now we have worst approved ability let me remove this okay and use my thing in extremist an okay things are unpredictable in video Christine you can predict things all right so that's point number one unpredictability is a problem in of course in a real world unlike the textbooks I've seen you guess you've seen this before you recognize this item this is commonly known as what a wheel very good what was it discovered sorry long time ago how long ago but at least 6000 years ago alright Babylonian technology right so this is technology so let's see moving from this technology to this technology you guys are too young to remember the days when it had to slip to carry our luggage because in have wheel how long did it take 6,000 years to miss discovery right ok so you realize that there is unpredictability not only that but now we're going to look at something else that they are domains that are entirely dominated by the unpredictable medical discovery for example entirely dominated by the rare event they don't know it and we're going to talk now about luck with a caveat it's not really luck it's a function of luck how to exploit luck by which you get more upside than downside of luck so and the idea is you know what this is windmill the two approaches in life the first one that you hear that they're going to be wins would and you know the conservative attitude is to build what a wall to protect oneself from the wind a better attitude is to build wind bales if you hear their well ok so the idea is to milk uncertainty and try to exploit disorder but before getting there we're going to have little excursion into what I call fragility there's something interesting that I discovered that took me about 21 years to figure out 21 years I was an option traded for 21 years and then realized something I knew unconsciously but only became conscious of it one day as I was looking at this patently ugly teacup all right we have a definition of fragility very simply connected to what we saw about options and let me let me propose the following its fragile what doesn't like volatility if this teacup is on a table and there's an earthquake will it benefit from it no you say very simple it is it wants fragile because it wants calm and predictability its harmed by disorder you guys have earthquakes in California it doesn't want an earthquake it doesn't want to be in California I'd rather be in New York you see very simply and now from this concept of fragility we're going to get into innovation and optionality so this the way I see it is short optionality and let's look at what short optionality is I think my computer is improving but I think it's within the system that there is a problem okay I'm talking to you guys I'm worried about my computer because I did something on Mathematica for coming so understand two hours of work you're operating this is a payoff of a financial structure that is very vulnerable to phone calls at night when villainized the chairman of the company gets a phone calls in oh there's an event so this payoff this package you know you make or lose some money but typically the losses right are very large and the profits are very small exactly like the coffee cup except the coffee cup has no variation except for the loss the coffee cup will never improve let's see if you can connect this this package is robust and this package has an opposite payoff where all the gains are large the kind of thing that only people in California seem to understand people in New York they don't get it because people in New York have this payoff and let me explain the banks are in a business of hiding risks so they make make make make make make small they have no volatility you know most of the time and once every 10 or so years guess what they lose everything they made and then they come to the taxpayer for support they they have the set up for people to you know give them monetary policy to help them and all that stuff and meanwhile they keep their bonuses because it's a very efficient strategy where you make you make make everybody think you're smart and then when you lose guess what it was it was a bad environment okay it was only a quarter when you lost but visibly you've lost more than you ever made banks lost in 2008 modern history banking alright and and of course they paid themselves a lot of money they didn't return it to us so this is a payoff that's very similar to a short an option you sell an option you have very little return you earn some money but then something happens you have unlimited losses or very large losses that pay off resemble the fragile the opposite of that payoff would be something that's long volatility so when I went you know to try to explain this people were understanding that the opposite of fragile isn't robust it's not solid it is not the opposite of fragile the opposite of this is not the straight line it's not a payoff you know where you know you end up unharmed you agree if I'm sending a package to say Mongolia interior right and the package is fragile what do I write on it fragile alright okay if the package is a robust but you write on it nothing so if the package once volatility wants to be harmed wants something one stressors wants disorder once earthquakes all right it's not the same as robust it would be something on which you'd write please handle I am anti fragile it's the opposite of fragile so the opposite of fragile is not something that is robust or something solid it's something that was disorder and guess what there is something called the cluster and if you like one you like them all uncertainty variability and perfect incomplete knowledge transkei loss these if you benefit from all of these you are classified as anti fragile and it's very similar to someone who owns an option so we're going to talk about you know how you guys can milk randomness because that's what you do in California right and we're going to be a little more technical and a little more rigorous in a way we analyze an option payoff so that was my idea of what an option is and why people don't quite understand what it means this computer definitely doesn't like me today maybe the proximity of Apple caused me to make these you know just to have this problem okay so there are things now let's do the world in three categories there's a fragile like this computer you pour water on it it's gone right you understand and now we have to give a lecture maneuvering with a mouse and maneuvering so it doesn't blow up and hope it can doesn't blow up before the end of this lecture right that's a fragile okay that's the definition there's a robust you hammer it nothing happens but doesn't benefit from it and there's the anti fragile that likes disorder and benefits from the solar and benefits from error so happened that now we can identify the fragile there's a method to figure out what is fragile and there's a method to figure out what is anti fragile how very simple something related to convexity let me explain what I mean by numb by convexity or concavity okay if I jump I am fragile my body is fragile okay if I jump 10 meters what would happen to me you guys are engineers and smart people who you would know what happened what would happen to me sorry screech I die I'm gonna say it this is you know you die in hospital you hospital here won't be any good right you die when you fall ten meters but if I fall ten times 1 meter what would happen to me nothing it means that every additional meter harms me more than the previous one no aha everything fragile we saw it in time series space but if you look at it as a response everything fragile has to have accelerating harm at some point and we can actually show that everything that has an accelerating horn doesn't like volatility and the opposite of it is something that has accelerating benefits you see let's you know look at it those response and the best example and everything and this is universal this is what I find is 495 maneuvers computer come on please please sorry the what the blazes it's working you know we're maneuvering with this all right so the the nonlinear is on more you see this accelerating harm is harm a lot more than the linear and visibly the linear for small variation so more response than the nonlinear this is very this is easier to understand if you look at it this way you saw that my the horn I get from hitting the floor okay it has to be nonlinear for me to be harmed at 10 meters but not to be harmed at 10 times 1 meter you agree ok it has to be that way because walking you know from on campus would kill you otherwise because being harmed by that large but you get the if it is if the thing were linear you'd be killed so harm for anything that has not been broken has to be in a non linear the coffee cup sees thousands of hits very small intensity like very small pounds per inch it's it doesn't really care but one big hit and it breaks so things that are fragile have to be nonlinear and this is what central abouts idea you have to be accelerating and harm another example is look at the world around us okay if we were linear - horn will blown up long time ago the world has three to four million earthquakes every year lower low intensity on a guy geiger scale you say it would be like a Fukushima every few minutes if it were it's the HAR more linear but it's not see yeah yeah so this is quite central because now we can figure out where the fragile from nonlinear and look at its opposite simply we have the following if you have more gain say if the market goes up 10% you make more money than the market went down 10% then you lose it the market went down 10% your convex you see and otherwise you're concave the best way to figure it out is with this this is convex this is concave if you want to remember this is convex and this is concave okay so if you look at the payoff of the convex you make more then you lose you're here you make more than you lose here for an equivalent one or you make more the second time than you make the first time the market goes up 20% you make more than twice its market one up 10% if you are in that situation then you like volatility if you're in that situation then you are like benefiting from randomness that what I call the disorder brothers uncertainty all these things let me take one or two questions here before continuing and as you're asking the question I can look at and see if I can fix the computer yes the upside of the convex curve but it seems to me that on the other side of your smiley face you would lose no ya increasing has to be increasing but you're not going to be here also I mean it's not going to be harm here this is F f of X and this is X and if you're here you say or decreasing but not very at a decreasing rate you say for the increasing all right you make more than you lose and for the decreasing it slows down any other question the idea is for you to see the connection between convex the idea attitude connection and lights volatility think about why the convex likes volatility you can do it here instead of getting X all the time you're getting X plus 50% sometimes or X minus 50% sometimes that linear combination is much better than just getting X so we like volatile you like variability that's why you know the answer fragile but all this is linked the same graph can explain to us now why being in your business is great has this been moving on its own or no when I was here I'm sitting here you see I told you this technology is not very reliable so I did the very similar okay I did a simple very simple experiment on my computer I generated two kind of series one where a person knows where he's going very intelligent person who knows where he's going but doesn't have any convexity in his payoff the other one the person who doesn't know where he's going has no idea but has convexity in his payoff you say look at the difference between the two trial and error is an option why look at trial and error as something like this you loose loose loose loose loose loose loose and once in a while you make a lot you say exactly like the opposite of the coffee cup like what we saw before something that gains from disorder and gain from black swans that's trial and error okay you're in the business of trial and error someone who tried does trial and error versus someone with directed ideas is going to perform extremely well when you have randomness and what we're going to see is why when you have trial and error you outperform someone who knows because convexity matters a lot more than knowledge you don't know what's going on you keep trying to have an irrational or laughs rational enough not to make mistakes by doing the same trial twice or having a result and giving it up so we can generate rules from this and I was thinking of seven rules because people like the number seven look here seven money rules for life there's here seven rules for success all right seven rules for weight loss all right you can do that as well and seven rules for change management okay so I also say okay I'm going to come up with my seven rule but then I realize you guys will not remember the seven rules as you leave this place so you have to understand how an option works and once you understand how an option works then you understand one word how to milk to have to be in a position where you are anti fragile and benefit from randomness it's a big big big misnomer that trial and error you know or lock benefiting from luck all right is a good and is the word trial and error is a misnomer we should not say trial and error you should say convex function of randomness or trial with small error okay trial and add the error has to be small so the anti-federal your environment where the errors are small and of small cost and the gains are large and unlimited and then you are positioned properly those that lacks one unpredictability all these things this is what central and you can model it exactly like an option and an option increases monstrously in value when there is volatility now there's some good news and bad news is that people don't quite understand that optionality concept in this book for I'm attacking the notion that we got to where we are because of the superb and collect and brilliance of the ancients that's not the case we got the way we are thanks to people who are taking risks involved in trial and error the problem is I call it lecturing birds have to fly people birds you know if you lecture Birds tell them this is how you should be flying and birds will fly according to your principles then you can claim credit you agree and then everybody would believe that because you never say it's called epi phenomenal because you never see the birds flying without someone lecturing it okay now it's the same thing with the problem we have is education right people have this impressive this idea that science race technology so if you take a book any book you have this idea science technology all right practice it looks like it's exactly backwards in history but the problem is that birds don't write books last time I checked who writes books those will lecture birds so we have a next generation of people who will forget you know how it was before now let's take the history of technology to me it comes from optionality discoveries and then someone formalizes it and dresses it up as you know this is directed research this is from a top-down and in fact all comes from trial and error you don't know where you're going you don't know where you're going but the harm is small so it's much closer to King you see how do you cook trial and error you agree you can't you don't take a chemistry class even except if it's a with T now you know because she wrote a book on chemistry of cooking but but you don't really take a chemistry class then work out the equations they're chemical and then get your perfect dish know how does it work you try you taste the harm is small if you're wrong and by little by little and after three or four generation of trial collective trial and error you get a good dish like choucroute or you get whatever or sourdough bread or kind of thing you have here you see this is cooking well it looks like technology resembles cooking but we read the wrong books and then matter of investigating how things were derived you see whether it's optionality or whether it was knowledge in book for a start book for with this story by Aristotle he was talking about Alice of mellitus okay and Dallas made a killing he was a philosopher and he was tired of the people who were telling them listen philosopher you know you're a philosopher you're schmuck you get the idea you can't make money plus the guy was Phoenicians so you can't make any money who is tired of these people he wanted to prove that he was philosophizing because he loved that business not because he was incompetent all right now moving on it by itself or as moving left if you've noticed going backwards to the seven rules okay so what did he do he went in and put some his money some bets on olive presses weight-loss business it's okay so he put some money on all the presses he went in and make made a bet that was going to be a demand for olive presses he put a little money on it and of course there was a lot of demands the season was great and he made tons of he made a fortune okay now what does Aristotle write that Alice made a fortune because he read the stars and predicted okay a great season for olives all right high demand for all presses but in fact what the Tallis have he had an option he had a down payment a call like the right to use the olive press by putting very little money on it they say had he been wronged it would have cost him nothing so we just ride ten thousand times over about ten thousand times maybe ten twenty thirty whatever high number of times at no big harm you see he would have been breaking even you know breaking even breaking even breaking even and making a killing once in a while and that's where really what he had is a big payoff that was to what Alice said was a big payoff not really it didn't come from this is moving on his own all right so so the so let me try this shutdown and restart do this okay so so the the problem with with with Dallas is that was a story is that we have this impression oh and I'm only two miles from Apple okay the problem with a story of Dallas is that they were convinced people were convinced that all this great thing came from knowledge when in fact goes from trial and error and then if we continue I what I did here and I can find it here probably in the book which also his wife but you see much less fragile because you can still wet book doesn't play tricks on you you can figure out that in a history all right a lot of things that were discovered by trial and error that later masqueraded as coming from top-down research and then nobody gets credit for trial and error we've known for example lot of things think of Euclidean geometry you think that we need geometry to put buildings now that's what people think no all right we had York Lydian geometry since the second century okay all right the people use it to build you know these big did the Romans use it no nobody used it they had their own heuristics their own tricks come in from trial and and they only used it later okay after the 15th century by the 15th century there were only four people capable of do making a long hand division in Europe so I take that example another example is another example patent example other than sorry which one pyramids avoid the pyramids I were built before you take a lot of things I'm sorry Peninsula what penicillin was disgusting in medicine is discovered like viagra but by by error a side-effect of something else and then people you know like viagra as the nurses were were complaining from behavior on its floor with it on the trial so you get the idea for a and it was a blood pressure medicine so the there are a lot of examples of stories backward even cybernetics you think is Wiener normal Wiener in fact just someone sent me a book as I was writing this about the the that it was practiced by technicians way before and of course no credit for them you say so the this computer is this is the first time I encounter well now it's working look it's not working okay the so let me take some questions here as a computer as I find my bearings let me take you a question on this yes isn't there in general and mix that is true so there's something called yes the bacterium in the stomach that causes ulcers it has always believed that there was no bacterial estimate when discovered could encode by chance by two guys went on vacation left things no not came back but it was not by chance that the end of the step okay soon as a mix of it there is a mix coming for optional case when you mix the two but effectively there is some kind of improvement in scientific knowledge built from optionality you see improvement that helps you conduct other experiments but typically the role of knowledge is highly overstated so we have this impression that things were driven a lot more by design than they were by luck you see but the point is it's not luck it is a convex function of luck it is by thinking it's a convex function of luck this is what is quite important in this is that you had more upside than downside to whatever you're doing the biggest improvements we had in meta didn't discuss drug discovery what was what people had no idea what they're doing but knew that the kept trying dies okay till they found something and today we're directing and we haven't been able to find much now we know that you know we know so many things we understand bacteria virus that we haven't been able to find as much as we did in a period when it's purely trial and error so we continue with this idea of trial and error has optionality leads us remember the seven rules okay - maybe you can make 77 rules you can make lot of rules but the principle should always be to be on the right side of convexity because convexity will pay you a lot more in the long run than direction so what do you do it the first thing is make sure that you have optionality you're not locked into a business plan like you're not locked on a highway with no exit yes people know that if your convex you're you benefit from extra bone yes but you've now polarized this idea right this is no I mean and maybe people knew about it before so who are you going to buy these options from could be for every person that says this is very interesting now when we talk about anti fragile is gains from randomness and volatility the in financial option you buy the option from someone you agree but in real life is or buy it from anyone trial and error you're not buying it from anyone this is not a financial option this is a real option that's number one - you still have an option that you're buying very cheap whenever you buy if you buy a house and you have a mortgage you already have an option you see people don't understand you have the option and for a long time for a long time you know people were getting even greater options from banks so the built in the explicit option is not what I'm talking about here what I'm talking about is embedded option in things or option like characteristics inch things and if you take the formation of wealth in history it all came from this optionality other questions yes like in an industry right for the airline industry where the errors are costing with toss you know okay - but there is explicit trial and error where you are willing to take the error okay there's explicit trial and error this is a system that has explicit trial and error where you you know you think are voluntarily and you have to maintain your error small and make sure it's not like a lottery ticket where the upside is known someone's overcharging you for it as a financial option and it's open-ended you see the the but but also their businesses okay where you make mistakes in which case you want to make the mistakes as small for the system as possible and never let a mistake go to waste by exploiting them so let me give you an example you know you just mentioned the transportation industry okay every plane crash which is an error leads to the improvement of the safety of traveling we haven't had a plane crash in America commercial the commercial plane crash in one or three years and before that it was more than three years so or a lethal one so you realize that there are businesses that even if they can have a large error to make sure it's one at a time not like monetary policy where you have big mistakes or you know politics where we have one person make a big mistake that cost so much in lives and money like a war you see you want your mistakes to be small when you can't avoid having mistakes you want them to be to remain small and typically top down things make large mistakes this is what my idea of decentralization of you have to decentralize the errors by making sure they remain small and distributed okay but when you're willingly making errors because they're small and because there's a lot of huge cost when you're willingly then you want you say then you want to make error you want to make a lot of errors because they're not as harmful you say and the payoff come from it but remember one thing you saw my first graph where I was showing you the returns in this business okay the the strategy that immediately comes to mind from that is that you can't be directed if a lot of your returns are going to come from one what are you going to do what you need to do you had to be as broad as you can in your strategy that's number one but you can't do it if you're an entrepreneur an entrepreneur bye-bye-bye-bye design is not broad and if you're going to have trials you could probably you can't have the 20 trials in a lifetime but collectively Society has been benefiting from this army of entrepreneurs very few of them managed to buy the big houses around here here real estate she's telling me it's hugely expensive you see very few win and then the remaining people are like soldiers who fall in battle for the sake of the system which is why I was calling for a national entrepreneur day and and then suddenly it happened by the way all right but didn't get credit for it it happened on publication on the pub day of the book by the way so the the entrepreneur day because hey you know what we salute fallen soldiers as some because they're needed for the system for the collective that needed for the system to further to prove the system we need soldiers to fall we should do the same for entrepreneurs because realize how few win and you don't want the other ones to be demoralized you want to thank them for getting involved in their side of trial-and-error without having anything but errors all their lives but they're doing it for the sake of the system and this is what it is see there's something moral about what you're doing if you try and you know to improve the system something moral even if you fail especially if you fail you say and this is what people don't understand we bail out we tend to bail out corporations that are rotten and fragile okay we don't bail out entrepreneurs which would be bailing out entrepreneurs which should also make it more honorable the only place I'm honored to be here the only place on a planet where it's honorable to fail is here before that it was used to be guess where couple centuries ago where no no an entrepreneurship an entrepreneurship sorry England England that pulled out at Industrial Revolution thanks to these aggressive thinkers you see so you have that was that was when and now with the problem is look at England what happened to England the minute you get rich from tinkering you had the illusion of being able to replicate it through Whitehall an economic policy and Whitehall research policy and this minister of policy and stuff like that they didn't have that when they pulled up you see and the minute they had that of course they went to the relative decline compared to other places so so you see you have to let the things develop organically on their own and thinkers are mad because that's how systems operate let me take more questions yes I'll conclude with the question Pierre go ahead Terry Paul students ago and ten minutes where they're talking about ending quantitative diesel and then quantities could leak inadvertently uses I'm sorry he's asking me he's telling me that something not related to the stock but he knew that I'm very interested in topic which is federal policy today leaked that they're ending quantitative easing no I'm not involved in journalism or or commenting I'll put it on on events but I'm going to talk about monetary policy okay if you later we should exact the thing is what the Fed has has been doing the idea of the government they don't understand antifragility they don't understand that when you have a crisis it should come out of it better than you were before you guys had your crisis in California and remember 2000 you weren't born many of ok so almost all right so you came out of it better off than before know it cleaned up the system so you should never let the crisis to waste now what happened in Japan and here and in Europe they have a crisis now they shoot to establish the system to bring it back to what it was before without letting what is fragile break and new things come in its place you say so the monetary policy aims at preserving the satu quo and then also a side effect is of course to enrich those who who were involved in the crisis right in causing the crisis and of course it's not good to have such a you know to have very easy money because you don't want people to take money and go gamble with it in the stock market you want it to go use the money for what you're doing the real thing is a trial-and-error that that they don't get respect for for losing a little bit all the time other questions yes relevant bankruptcy which essentially grants the original proprietor is the ability to keep on doing what they do what do I think about chapter 11 I have a written two things about the notion of limited liability okay the the if it's used okay for this trial and error then it's very good if limited liability if limited liability is use to transfer your losses to society so you get the bonus the upside and society gets the downside then it's not good you say and what has happened in the catalystic system is instead of having incentives and disincentives we have some people who have the incentives and then when they lose money take banks they make bonuses when they have good years and then when they have a bad year they transfer it to society so the taxpayer and they keep their bonuses as we saw before again remember the two kind of pay off the pay off where you lose a lot to make small and the other pay off which is what you have here when you lose small to make big you say now those who lose a you know a little bit who you know lose a little bit to make big are not gaming the system because the taxpayer doesn't bail you out have you heard of a bailout of any company in California no because you guys all your big volatility of the in the upside not the downside you see but the other ones has a big volatility to the downside and they lose more than their capital and someone has to pay for the losses it ends up needing a tax payer other questions yes everything yes so you have all these things to say about the nature of building being able to predict things but we also use probabilistic AI a lot and we are using it more and more in every fuel okay he's saying he's saying that I I'm sceptical about the use of probability to predict and he told me that in AI they predict a mediocre Stan you can use probably very well it works very well outside mediocre Stan when you have things dominated by rare event okay the these things fall apart and they fall apart I have I just put the text because nobody was understanding my Black Swan they would read it and comment and write articles I'm not even wrong about it my point is that large deviations occur they are unpredictable okay no matter how many phd's you put on it they're unpredictable and all the people who relied are predicting rare events have blown up and this is how actually you can make money on Wall Street you identify those will rely on probabilities to compute the risk of rare events and make sure they're going to go bust like Fannie Mae or like others and you can make a buck and celebrate you know being right with these guys so I'm saying but if we're a I you can apply it for small problems that don't have big tail effects yes you can definitely apply it we use probabilities for anything for for insurance for on your house for insurance medical insurance is probably works beautifully these domains and then casino is it perfect okay yes yeah brother us after the billion dollars and 25 years you got any idea yes when you have a okay how did we get to where we are today you lose small to make big so because you have to have a lot of trial to get to the destination okay if you are what I call teleological and a slide that I can show and think you know where you're going then you can bypass a trial and error because you have great scientists and great scientific understanding and it looks like Pharma got to where it is today through accidents the side effect of drugs side effect the thing and now suddenly they woke up and said okay now we're going to target results you say when in fact it's a collective effect of a lot of firms trying and those who succeed thought that they succeeded because their brains not that they succeeded because of their taken advantage of luck you see that's the problem of pharma today and pharma has more problems than that in the past you come up with a drug okay you had to look at side-effects and probably a few other drugs today we have 850,000 authorized drugs okay something like that and one hundred and some thousand existing drugs alright so every time you introduce a drug you got to look at side-effect our patient and you got to look at Co you see Co side-effects and then you have to look at try side-effect with sweet and all these drug interactions that you had becoming more and more unpredictable so Pharma is in trouble in that sense plus there's another thing in my book here that I discuss about the subsystems that sometimes curing people it's much easier to do by subtraction you see subtraction is much easier cz7 rules all these rules are positive means do this to this to this as much the Charlatans typically have nothing but positive rules people who are you know scientist or philosophical have negative rules okay don't do this don't do that it's much more rigorous actually and they don't have side effects so if instead of curing people by giving them drug every time we looked at subtractive methods remove things like for example remove cigarettes from society you save more it's more effective than anything we're spending on drugs and cumulatively more than anything done since penicillin they say I don't believe the statistic when I saw it and in fact it or not to be true if you just remove cigarettes if you remove corn sugar okay remove by removal if you remove diabetes the first thing people do is give people drugs nor if you send them to Siberia or didn't have the money put them on 500 calories a day for 3 months come out of it fluent and Russian or reversal in Russian and it's more effective than any drug initially alright but what the protocols you start instead of starving people because it's a stressor that someone needs we aren't anti facial to variation if we derived of if we are deprived of these variations we get weaker so if you if you some people the first thing they do is try to give you a drug instead of removing right instead of removing food try to give you something and effectively now epileptic see if you have you know a child has at you know that exceeds the first thing they do is give them drugs whereas the most effective treatment is removal of all sugars you say and we know if no now for 70 years but Pharma doesn't make any money removing things from your system nobody's going to make any money if you stop smoking directly if you stop smoking they're not going to sell you something unless they sell you method to stop smoking you see so this is what was the problem there's a gentleman in the back it's hard to disentangle luck and ability such as trading how do you device an effective compensation or payment scheme I believe in something I call skin in the game okay skin in the game is a defined skin in the game it's most moral and effective to remove risks is that nobody should ever put someone else at risk I don't really care about compensation okay I don't really care about ranking because you can't have a trading competition because someone has a strategy that pays off very rarely okay he will lose in the competition he lose every battle and win the war you see so I can't really rank traders but there's one rule I have a cold skin in the game that nobody should put others at risk without having harm to himself okay in other words if you lose money to your clients you should be exposed to the same risk that's sort of it most moral and risk management rule risk management because I'm Hammurabi's code it was simple as an architect build the house and the house is fragile but hidden fragilities in a basement you get the idea we're in the foundation like in a bank system banking systems they look very stable but they have they cut corners that nobody will see okay to make the bonus and if the house collapses the architect is penalized that was in Hammurabi's code actually is put to death if the house collapses and kill the owner of the house so this system okay is the best this is the best risk management rule because as Hammurabi discovered but some things I forget today in Washington the architect or engineer knows a lot more about the risks he doesn't know a lot about the risk but he definitely knows a lot more than the inspector you say so if you make people eat their own King you see their lot better off okay and someone sent me read my book and sent me something a story in Brazil where they discovered that they could lower the rate of helicopter crashes by forcing helicopter engineers randomly to take a ride have now arrived once a months and helicopter all right now sorry for example something the Romans knew and Victorian knew that you make engineer sleep under the bridge right okay so in trading what do you do so long as whoever is whoever is involved in strategy has losses small okay it doesn't matter right has losses if it can harm others in other words it has some incentive but some disincentive then we should be okay it's when people don't have disincentive when they lose that the system blows up yes systems are moving to areas and stays qualitex today's top-down so does your theory of antifragility have some implications or some suggestions on how politics should go forward to reduce experience the idea that I proposed is very simple along the rules if you look at these rules very simply that you want mistakes to be small and gains to be large okay and a mistakes side you want to distribute mistakes then you necessarily need the centralization you see the most stable country in the world is Switzerland where nobody knows who the president is all right they can tell you that there is Qaddafi's presence of this Asaf residue don't know their own president it's a system works well it's so decentralized it's completely bottom-up you see so mistakes are small so this simple concept pervading the book convexity means mistakes are small ok concavity means mistakes are large and rare you see at that simple system so we don't have any more time I have another lecture but thank you very much and thanks Apple could someone worked for Apple I would like to have word with them now thank you I'm driver faces stvp dfj and the many lovers of Finance are in this room and washing virtually we'd like to thank you thank you thank you very much it's not edible oh okay great thanks [Applause] you

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Published: Wed Apr 17 2013