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Just finished reading Nassim Nicholas Taleb‘s Fooled by Randomness, 2nd Ed.  Taleb illuminates simply, with stories, that reality is embedded with randomness (not predictable), nonlinearity (not easily forecasted using past data assuming a straight line) and skewness (not symmetrical), yet we humans often get confused by our biases and mis-apply statistics to describe reality.   Experts could be multiply fooled by the same biases and mis-applications.  

We confuse what’s noise and what’s signal; and our news and social sciences (in attempts to apply scientific methods incorrectly) inject more noise into the system.  On top of these are rare events, some black swans, that are rare and happen unexpectedly.  The bad ones cause havocs in the “normal” progression of life, while the good ones could reap great benefits to those who could catch them.  But these rare events could not be foreseen.

We don’t know “what we don’t know”, whilst we think we know.  According to Taleb, success is often the result of luck, or randomness, but we attribute success to one’s skills.  This is especially more prevalent with professions that involve randomness, like securities trading, or upper level management (big decisions are make infrequently and the consequences of the decisions are not seen until years later).  Even a streak of successes could be the result of randomness if the sample size of people in the profession is large.  Only repeated actions over a long time would one really distinguish between luck and skills.  Such is the distinction between a securities trader and a dentist.

Biases:

  • hindsight bias – overestimating what one knew at the time of a rare event due to subsequent information:  “I knew it all along”, when we did not see the rare event coming
  • selection bias – misinterpretationof the statistics from sample selection
  • attribution bias – cognitive bias that affects the way we determine who or what was responsible for an event or action
  • survivorship bias – the tendency to excluded failed companies from (finance) performance studies because they no longer exist

As Taleb is a voracious reader and reads in many fields, he injects lots of ideas into the book.  Most notable is that Taleb reveals himself to be a disciple of Sir Karl Popper, who challenged the singular reliance on observations and inductions to form scientific theories — any theory could be overturned by just observing a counterexample that was not previously observed. This last point hints at Taleb’s Black Swan, described in another book of his.   There is much to grasp as one reads Fooled by Randomness.

I highly recommend this book, as Taleb challenges us to be vigilant of what we don’t know, and maybe on occasions, be less a fool to randomness.  Very insightful, yet readable.

Copyright (c) 2008 by Waiming Mok

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