Risk, Black Swans, and Brown Turkeys

The mathematics of volatility and VaR alone are just not enough for understanding risk in today’s environment. We are living in extraordinary times – probably the most extraordinary in three generations. (Don’t get me wrong – I’m not arguing that we should throw out the mathematics and the quantitative tools. Unlike many others – there is a minor industry blaming all our current travails on the evils of VaR – throwing out the mathematics is patently absurd.)

But the risks today are really macroeconomic, political, policy risks, systemic risks; not the risks that an individual firm will run into trouble (JPMorgan’s recent loss notwithstanding). The risks are the big, existential risks of sovereign debt default, currency devaluation and debasement, inflation.

But we need to put all this in an historical perspective. We’ve been here before, in fact many times. It seems new and strange only because our collective memory is short. Our current situation may seem extraordinary by comparison with the past 10 or 20 years, but when we look further back in history, when we take a 100 or 200 year perspective, today’s events are not extraordinary after all.

My presentation at the conference on U.S. Expatriate Investing: Risk vs. Reward in an Uncertain World in January 2012 tried to put some of our current travails in an historical perspective. Why the title Risk, Black Swans, and Brown Turkeys? People talk about “Black Swans” – unpredictable and inherently unforeseen events – events that because of their unpredictability have a major impact. The term traces back to Juvenal, in Latin “rara avis in terris nigroque simillima cygno”. In English “a rare bird in the lands, and very like a black swan”. Originally meaning something that was patently impossible (since all known swans were white) it has come to mean supposedly impossible events which, when observed, completely up-end received wisdom.

But the term “Black Swan” is horribly over-used. There may be Black Swans out there, but let me assure you that the financial crisis that started in 2007 and continues today with the eurozone crisis is not a Black Swan. Before-hand it was impossible to predict when or even if the bubble would burst. But crises such as we are living through have been common throughout history and the current one has been absolutely no surprise to those who study such events. The current crisis would seem very familiar to a London banker living through the Barings crisis of 1890 (yes, Barings went under in 1890 as well as 1995) or a New York stock-broker during the crisis and panic of 1907-08.

Today’s events are better characterized as “Brown Turkeys” – events that are unpredictable, surprising when they occur, but are out there if you know where to look. If you have ever tried to hunt turkey you will know that they rarely show their face, particularly when you are hunting them. But the woods are full of them. (At least at my father’s place in West Virginia.) They are there, we just don’t see them. But just because they aren’t in our front yard every day doesn’t mean they don’t exist. We can’t predict when we’ll find one and it may be a huge surprise when we finally get one within shot, but only a fool would be surprised that they actually exist. We can’t predict when or where we might come across a Brown Turkey but any knowledgeable hunter knows they’re out there.

Read more in the slides (.pdf) or read through the complete lecture notes (20 pages, .pdf).

About Thomas Coleman

Thomas S. Coleman is Senior Advisor at the Becker Friedman Institute for Research in Economics and Adjunct Professor of Finance at the Booth School of Business at the University of Chicago. Prior to returning to academia, Mr. Coleman worked in the finance industry for more than twenty years with considerable experience in trading, risk management, and quantitative modeling. Mr. Coleman earned a PhD in economics from the University of Chicago and a BA in physics from Harvard College.
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