A Black Swan Named Swine Flu
April 27th, 2009
Just when it seemed that investors were beginning to feel a bit more optimistic about the worse being over for the world economy a potential black swan named Swine Flu swooped in from the flock that has been circling overhead for the past couple of years. The world’s economy just can’t seem to catch a break.
The theory of the black swan was described by Nassim Nicholas Taleb in his 2007 book The Black Swan. Taleb regards many scientific discoveries as “black swans” — undirected and unpredicted. Taleb thinks that the rise of the Internet, the personal computer, World War I, and the September 11, 2001 attacks are examples of Black Swan events.
The heart of Taleb’s theory is that black swan events occur more often than pure mathematical probability analysis states that they should occur and by definition black swan events are catastrophic when they do occur. Humans seem to have a way to bring about the appearance of black swans through their arrogance and ignorance. Many humans act like they know a lot more about any subject than they actually do.
From a probability point of view, the financial events that lead to a world wide financial meltdown can be classified as black swan events. Those responsible at the big banks and at Wall Street investment banks for computing the risk of creating and packaging securities backed by home mortgages thought that the risk of enough loans going bad to seriously impact the performance of securitized loan packages was extremely low.
In fact, they thought that the probability was so low that they didn’t have to really worry about it and therefore mispriced risk. When trillions of dollars of these securities did go bad notwithstanding their complex mathematical models that computed risk levels as being almost nonexistent the resulting meltdown was considered a black swan event.
Now a potential black swan event named Swine Flu has descended upon the world. While the epicenter so far has been Mexico City, in just a few days the disease has spread to the US, Canada, the UK, Spain, New Zealand, and probably to additional countries. Today the World Health Organization looked set to raise its pandemic alert level, indicating it believes that large outbreaks are possible.
The stock market began to show some concern today. Airline and travel industry stocks were hammered, and there is a growing concern among traders that if the swine flu turns into a pandemic a weak world economy could be severely impaired.
“The threat of the pandemic will add further weakness to global trade,” said Justin Urquhart Stewart, investment director at Seven Investment Management in London. “We saw with SARS tangible percentage points knocked off the index, and that was in a buoyant time. Put that in a weaker time and it is likely to be more unpleasant.”
As the outbreak of swine flu is a new fast moving event with an uncertain outlook should it grow into pandemic proportions the recent rally in world stock markets could come to a brutal end.
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As if the economy itself wasn’t difficult enough to deal with! Well, the swine flu situation (not to mention the whole “black swan” concept in general) just goes to show that even things that should be as broadly predictable and numbers and economy are subject to the “human factor”!
Each new flu has the potential to be a black swan according to the forbes article which I read couple of weeks back. The fatality rate of the recent outbreak is much low when compared to the earlier ones. Thanks to the awareness created by govt and media. Similar awareness programs should be created for black swan theory too.. what do you think?
I like the name – Black Swan. Yet I don’t think we should really be surprised with unpredicted events – the internet, the pc, and Sept. 11 Terror Attack, what I mean is that life itself is unpredictable and so is the future. We don’t know if the world is going to end tomorrow, could that be called also as Black Swan.
Kim@get money quick´s last blog ..8 Ways to Get Money Quick
Great comment about investments