I

t was unfair really, and informs those nearest

but perhaps not alto- to the door that the proposi-
gether unexpected. tion for debate just finished
On a late October day should have been “This house
in 2001, the English believes that most city hot-
weather unwilling shots are lucky fools.” Taleb
to commit to any- had been expected to argue
thing discernibly seasonal, from the less nuanced posi-
Nassim Nicholas Taleb walks tion that all city hotshots are
into the relative comfort of lucky fools. He deserved his
the Cambridge Union bar drink.

30 Wilmott magazine
Wilmott magazine 31
 TALES OF THE UNEXPECTED
Misunderstood then, misunder-
stood now. Wall Street’s principal
dissident. Heretic! Calvin to finance’s
Catholic Church. His second book,
the treatise Fooled By Randomness,
drew praise and derision in equal
quantities. ‘Taleb is a breath of fresh
air and tells it as it is!’ ‘Taleb either
states the obvious or makes gener-
alizations to the point of ludicrous-
ness!’ Either way, people were
quite breathless.
The book is accessible. What a
double-edged sword that is. It brings
with it the consequence that anyone
literate in any of the 17 languages it
has been published in feels able to
formulate an objective opinion on
it. Because it’s all about dumb luck,
isn’t it? It leaves you with the conclu-
sion that modern finance has gone
long on snake oil. Boo hoo! The other
conclusion that we draw is that it’s
all just so much noise. Calm down!
So, the Cambridge Union invites
Taleb to debate, given the exact word-
ing of the proposition it’s barely
The problem is that we are all
Platonists, we automatically look
towards an ideal state, one that
makes sense (always in hindsight)
32
worth discussing any further. And
the final count? Abstention was the
order of the day; a protest against
globalization. Go figure.
Taleb takes a hammer to the lib-
erty bell. This is an enjoyable specta-
tor sport. He desecrates the bell curve
and the entire business of statistical
inference; the sanctum sanctorum of
the priesthood of modern orthodox
finance. Who do we see turning
the tables outside the temple? Your
understanding of randomness is
wrong! The Gaussian only fits with
non-scalable, usually physical phe-
nomena. And it goes deeper than
that. The reverberation from that big
ding-dong shakes us to the founda-
tions of modern finance.
In his latest essay, The Black Swan,
Taleb takes us on a trip to the lands
of Mediocristan and Leptokristan,
but at the heart of darkness he finds
Plato, or at least the band of Dennis
Hoppers he inspired.
You will recall from your brush
with philosophy that Plato had a
Taleb (with Espen Haug, and Benoit Mandelbrot) on Mandelbrot: “I will fight to the
end to promote his method as a framework to look at deviations”
thing about pure forms. As a lover of
wisdom, a philosopher, one should
turn away from the distraction
that is the empirical world. In the
empirical world we only see particu-
lar cases of a universal, the beauty
of a woman or that of a statue of a
woman are instances of a universal
beauty, our reference in physical aes-
thetics. We have an understanding
of ‘beauty’ prior to our reference to
it in a particular case. Furthermore
we are able to qualify comparatively
between two objects we find beauti-
ful – the Platonic argument is that
things in the physical world are
all compounds of various qualities
– which do not in themselves exhibit
perfect beauty but tend towards
an ideal beauty to some degree.
Therefore, since we have a sense of
what ‘beauty’ is prior to applying
it to a particular object, and we are
able to discern between the levels
of beauty inherent in two objects
then there must be an a priori beauty
which we have an understanding of
in order to make that aesthetic judg-
ment in the particular case. In order
to make a classification there must
be a universal class under which
these objects would be subsumed.
The problem is that we are all
Platonists, we automatically look
towards an ideal state, one that
makes sense (always in hindsight),
one that ignores the aberrations,
the one that can stand up with us
when we sing the national anthem
of Mediocristan.
Mediocristan, Taleb explains, is
the land of the bell curve. That is,
no doubt, what they have embossed
on their license plates there. This
place is a ‘province dominated by the
mediocre, with few extreme success-
es or failures. No single observation
can meaningfully affect the aggre-
gate.’ So human height is a perfect
example, because out of a sample
of 1,000 people, even if one person
were twenty feet tall it would make
no impact whatsoever on that com-
forting undulation. Randomness
here is mild.
Leptokristan displays a wild
randomness, ‘a province where
the total is impacted by a single
observation.’ So here you will find
the distribution curve for, let’s say,
personal wealth of 1,000 people, and
one of them happens to be Bill Gates.
Wilmott magazine
 TALES OF THE UNEXPECTED

Platonicity Glossary
Nassim Nicholas Taleb provides a
brief guide to his key themes
Platonicity: the focus on those pure, well-defined, and
easily discernible, objects, like triangles, or more social
notions, like friendship or love – at the cost of ignoring
those objects of seemingly messier and less tractable
structures.
Nerd knowledge: the belief and custom that what can-
not be Platonized and studied does not exist at all, or is
not worth considering. There even exists a form of skepti-
cism practiced by the nerd.
Ludic fallacy (or uncertainty of the nerd):
Manifestation of the Platonic fallacy in the study of uncer-
tainty; basing studies of chance on the narrow world of
games and dice. Aplatonic randomness has an additional
layer of uncertainty concerning the rules.
Epistemic arrogance: Take a measure of the difference
between what someone actually knows and how much he
thinks he knows. An excess will imply arrogance, a deficit
humility. An epistemocrat is someone of epistemic humil-
ity, who holds his own knowledge in greatest suspicion.
Epistemic libertarian: Someone (like myself) who con-
siders that knowledge is subjected to strict rules, but not
institutional authority as the interests of organized knowl-
edge is self-perpetuation, not necessarily truth (just like
governments).
Narrative fallacy: our need to fit a story, or pattern to
series of connected or disconnected facts. The statistical
application is data mining.
Narrative discipline: discipline that consists in fitting a
convincing and well-sounding story to the past. Opposed
to experimental discipline.
Platonic confirmation: You look for instances that con-
firm your construction (or model) –and find them.
Platonic fold: The place where our Platonic representa-
tion enters in contact with reality and you can see the
side-effect of models.
Scandal of prediction: the poor prediction record in
some forecasting entities (particularly narrative disci-
plines) mixed with verbose commentary and lack of aware-
ness of their own dire past record.
Epistemic opacity: Randomness is the result of incom-
plete information at some layer. It is functionally indistin-
guishable from “true” or “physical” randomness.
Black-Swan blindness: underestimation of the role of
the Black Swan, and occasional overestimation of some
specific one.
Round-trip fallacy: the confusion of absence of evi-
dence of Black Swans (or something else) for evidence
of absence of Black Swans (or something else). It affects
statisticians and other people who lost part of their rea-
soning by solving too many equations.
Fallacy of silent evidence looking at history, we do not
see the full story, only the rosier parts of the process.
Future blindness: Our natural inability to take into
account the properties of the future –like autism does not
allow the patient to take into account the existence of the
minds of others.
Circularity of Statistics (the statistical regress
Argument): We need data to discover a probability dis-
tribution. How do we know if we have enough data? From
the probability distribution. If it is a Gaussian, then a few
points will suffice. How do you know it is a Gaussian? from
the data. So we need the data to tell us what is the prob-
ability distribution, and a probability distribution to tell
us how much data we need. This causes a severe regress
argument.
Scorn of the abstract: Favoring contextualized thinking
over more abstract matters. “The death of one child is a
tragedy; the death of a million is a statistic”.
Retrospective distortion: Examining past events with-
out adjusting for the forward passage of time. leads to illu-
sion of posterior predictability.
Mediocristan: province dominated by the mediocre, with
few extreme successes or failures. No single observation
can meaningfully affect the aggregate.
Leptokristan: province where the total is impacted by a
single observation.
Black Swan ethical problem: asymmetry between the
rewards of those who prevent compared to those who
cure.
Problem of induction: Logical-philosophical extension
of the Black Swan Problem
Bell curve (Gaussian): or GIF, great intellectual fraud.
Application of the ludic fallacy to randomness. There is
a qualitative difference between Gaussians and scalable
laws, much like gas and water.

There is scalability here, and the ride
can be much, much more volatile.
Deviations from the mean are not
exponential.
Taleb introduces us to the Ludic
Fallacy, he asks us to stop talking
about casinos and games when
we want to discuss uncertainty.
Why? Well, more of that in the
interview, but suffice to say it’s
because the house always wins.
“The Leptokristan /Bell Curve gap
is a simple application of this Ludic
Fallacy.” Taleb says, but don’t get
him wrong.“My problem is noncom-
putable odds, whether bell-curve or
scalable. It is just that I prefer the
scalable as a statistical paradigm.”
The epistemological ground-
ing of finance the ory is unsound.
Because just as men are from Mars
and women are from Venus finance
is from Leptokristan and mundane
matters such as distributions of
height, weight and calorie con-
sumption are from Mediokristan.
In a way there are a lot of people on
Wall Street or in the city of London
who go to work every day in drag.
You have often read the following
words: “Assuming a Black-Scholes
world …” We believe we operate in
Mediocristan but in fact it is the
wild shores of Leptokristan upon
which we have been washed up. If we
lived in a Black-Scholes world, LTCM
would not have happened.
This was a viewpoint that many
experienced traders did not find
difficult to accept when Taleb first
developed it in Fooled by Randomness.
The Black Swan is not about finance,
it is about the philosophy of history.
But it carries the same warning.
Wherever you encounter people
saying something is statistically sig-
nificant, it’s a sure bet that they have
looked at their observation errors
and assumed the big bouncy bell
curve is in play. But the way that we
interpret those samples? We ignore
the unseen, the unknown and the
unexpected. Recall Taleb at the end
of Fooled By Randomness, watching
Odysseus battle the pull of the
sirens song, and taking away the
lesson that one should not attempt
to emulate the man tied to the
mast, but accept that at best we
could hope to plug our ears with
wax and live with randomitis. Here
in the Black Swan we are at sea once
more, Diagoras, when shown the
offerings made to the gods by those
who survived their sea voyages
asked, what about the offerings
made by those now in the bosom
of the briny deep?

Wilmott magazine 33
 TALES OF THE UNEXPECTED

Nassim Nicholas Taleb:

He desecrates the bell
curve and the entire
business of statistical
inference

34 Wilmott magazine

Standing at the Platonic Fold
Nassim Nicholas Taleb brings us up to date on
the thinking that is behind The Black Swan
I
just finished the first draft of
the Black Swan – spent a year
hiding in cafés and libraries
working on it. I wanted to get
closer to my idea of a pure epis-
temologist, get rid of what trading
was still hampering me, going deep-
er into matters, as deep as I could.
But unfortunately I am now back...
(laughing).
How did you use quant finance as a
base towards philosophy?
NNT Quant finance proved to be a
wonderful place to learn the stuff, a
place to generalize because you can
see the explosive “Platonic fold”,
where reality enters in contact with
what mental representation we have
of it, where things are uncharted
but people are deceiving themselves
with constructions and calling them
science. It is better to start with
markets than the other way around.
Many people study, say, physics,
mathematics, probability, or psy-
chology to try to understand finance.
Then they show you that superim-
posing these ideas works beauti-
fully. A few might get rich for some
random reason, and then we impart
their success to their understanding
of psychology or socio-politics. So
people come to finance blinded by
some idea, looking for – and finding
– confirmation. I think that because
of the messy nature of knowledge
we have in finance, it is much prefer-
able to go the other way around. We
learn to think in an aplatonic way
Wilmott magazine
– away from what I call Platonicity.
Now I climbed up to the mother
of all the problems, the generator
of Fooled by Randomness. It was also
the problem with my earlier work
Dynamic Hedging where I examined
the contact between theory and real-
ity. Platonicity is the generator of
these problems.
Can you explain Platonicity?
It is the focus on those pure and
well-defined, and easily discernible,
objects, whether triangles, or more
social notions, like friendship or love
– at the cost of ignoring those objects
of seemingly messier and less tracta-
ble structures. Seeing patterns is a
form of Platonicity as we refuse the
mess of randomness. This is also the
product of our need for reduction
– we need to reduce, and Platonicity
has side effects.
Can you give us an example?
Take a look at a schoolworm picking
up a new language. He will learn, say,
Serbo-Croatian or !Kung by reading
a grammar book cover to cover, and
memorizing rules; he will operate
under the impression that some
higher-up grammatical authority set
the linguistic regulations so that non-
learned ordinary people could subse-
quently speak the language. In reality,
grammar is something that comes
after language, just as in any form of
scientific model. It is something peo-
ple without anything more exciting to
do in their lives codify into a book.
TALES OF THE UNEXPECTED
While the scholastic-minded
will memorize declensions, the
aplatonic non-nerd will acquire, say,
Serbo-Croatian by picking up potential
girlfriends in bars on the outskirts of
Sarajevo, or talking to cab drivers, then
fitting (if needed) grammatical rules.
The same applies to science. It can
be generalized to the manner that
some people have a personal inclina-
tion to dip into textbooks while oth-
ers pick up their knowledge on the
streets (there may be a few rare com-
binations). Consider the economic
planner. As with language, there is
no grammatical authority codifying
the economy; but try to convince one
of those economists that the world
might not want to follow his scientif-
ic equations. Indeed Austrian econo-
mists used the notion “tacit knowl-
edge”, about economic matters,
precisely for that part of knowledge
that precisely cannot be codified, but
that we should avoid repressing. It
just comes out on its own.
I learned from looking at finance
professors with some model taking
possession of their head. But the best
manifestation of Platonicity is with
the ludic fallacy
The Ludic Fallacy?
We are basing studies of chance on
the narrow world of games and dice.
Aplatonic randomness has an addi-
tional layer of uncertainty concern-
ing the rules themselves.
I called Ludic fallacy (after the
latin ludus, play) the misuse of
games as the wrong epistemologi-
cal ground. Let me show here how
randomness ends up disappearing in
these games. Just consider that you
know the probability, and that the
payoff does not change throughout.
The casino never surprises you by
announcing that it will be paying
you 100 times more, or a tenth of
your take. Furthermore, the dice
average out so quickly that I can say
with certainty that the casino will
beat me in the very near long run at,
say, roulette, as the noise will cancel
out though not the skills (here, the
casino’s advantage). The more you
extend the period (or reduce the size
of the bets) the more randomness,
by virtue of averaging, drops out of
these gambling constructs.
Alas, we suffer from the general
tendency by those who put their
noses too much into maps to mistake
the map for the territory. Go buy a
history of probability and probabil-
istic thinking: you will be showered
with a series of names you see recur-
ring in all these books, like Cardano,
Pascal, Fermat, Huygens, De Moivre,
Laplace, Gauss, De Finetti, or
Kolmogorov.
Contrary to what we were taught
in all these probability volumes,
and in the misguided books on the
history of probability and “risk”,
gambling could not offer us lessons
about real randomness, nor can it
be a laboratory where you could get
actual training for the messy real
life. As just as we tend to underes-
timate the role of chance in life in
general, we tend to overestimate it
in these games. It is the only place I
know where we have mild Gaussian-
style randomness!
Furthermore I found it infuriat-
ing to listen to people who, upon
being informed that I specialize in
problems of Chance, immediately
jump to references to the dice.
The ludic fallacy is present in the
following chance setups: random
walk, dice throwing, coin tosses, the
infamous digital “heads or tails”
35
TALES OF THE UNEXPECTED
The aplatonic non-nerd will acquire, say,
Serbo-Croatian by picking up potential girlfriends
in bars on the outskirts of Sarajevo
expressed into 0 or 1, the “Brownian
motion” corresponding to the move-
ment of pollen particles in water, and
similar examples. These generate a
quality of randomness that cannot be
even qualified of randomness – pro-
torandomness is a more appropriate
designation. At the core, all these
theories ignore a layer of uncertainty.
Worse, they do not know it!
And the ludic fallacy leads to
the Gaussian, the Great Intellectual
Fraud, GIF.
Beware the Gaussian?
The ludic fallacy leads to the use of
that monstrosity called the Gaussian
and its siblings. And fixing it is not
easy. The problem is that you
cannot naively fatten the tails: you
are in a situation of uncertainty
about the distribution. NonGaussian
randomness generally implies
that you do not know much
about the tails.
Consider the following. We need
data to discover a probability distri-
bution. How do we know if we have
enough data? From the probability
distribution. If it is a Gaussian,
then a few points will suffice – and
we know how many. How do you
know it is a Gaussian? from the
data. So we need the data to tell us
what is the probability distribution,
and a probability distribution to
tell us how much data we need. This
causes a severe regress argument.
The other one is to start ranking
results based on their dependence
on models.
36
Platonicity has an important
extension: categorization.
Categories?
We need to extend our uncertainty
to categories because categories are
fuzzier than we think and we tend to
want to see crisp boundaries. There
are many things we cannot separate
because they cannot be isolated. For
instance, utility and probability can-
not be dissociated.
Wilmott magazine is a second
home for me, simply because I found
credible like-minded people and
social friends who can either agree
with me, say Haug, or heavily disa-
gree, like Elie Ayache. Ayache by chal-
lenging my ideas has taught me a lot.
He is the only critic I have felt com-
pelled to answer. The others don’t tell
me anything I didn’t think about.
Ayache argues that it is the philo-
sophical foundation that needs to be
overhauled in order that quantita-
tive finance can be recognized as a
science. That to accept your com-
bination of skepticism and classical
empiricism leads in two directions
only, blind faith or skeptical resigna-
tion. He proposes to find a third way
through a rethinking of what a mar-
ket actually is. What is your reaction
to Ayache’s metaphysical interpreta-
tion of derivatives as being the path
toward this new approach?
This is where I disagree. The skeptic
in me is easily satisfied by my rank-
ing situations in accordance to their
robustness to model error, or their
Platonicity. For instance a portfolio
that depends on tail probabilities is
much less robust than a long-only
venture capital investment or a long
out-of-the-money calls. An arbitrage
with cash and carry is more robust
than a probabilistic one. You can
generalize into soft and hard knowl-
edge in real life, outside of finance.
As to metaphysics, I will leave it
for another discussion. My branch
of philosophy is that of statistical
inference, a supervision of scientific
claims, nothing abstract. But I agree
that we can escape problems by
rephrasing them, except that I do
not want to escape these problems.
I am both a radical skeptic and an
empiricist and I do not find the two
incompatible at all. The school of
empirical medicine in the second
and third centuries was grounded in
radical skepticism.
The real divorce for me is between
aplatonic view of the world and aes-
thetics. I want the world to be more
aesthetic yet I want to acknowledge
that it is considerably less so than we
think – or not where we think.
On the basis that our sampling is
wrong to start with when it comes
to assessing the value of a given
approach to trading and investment,
and that our programming doesn’t
allow us to (easily) accommodate
black swans prior to the fact it is
highly unlikely that a shift is going to
occur in finance toward the basis in
skeptical empiricism that you repre-
sent. Do you agree with this?
Finance is moving very quickly into
firmer grounds. People know of the
severe “Nobel side effects” and pseu-
doknowledge. We already know that
much of portfolio theory and modern
finance provide negative knowledge
because of their side effects, that
many hedge fund managers have
LTCM-style cosmetic alpha.
The next LTCM-style blowup will
help a lot.
Can you say something about how
an approach like Mandelbrot’s
would disabuse the market of this
dependency on the Gaussian?
Mandelbrot changed geometry. He
will change much of social science
– his model starts with the tails as a
central element, not some append-
age. It is a completely different way
of thinking –if you are going to be
Platonic, this is the way to do it. I will
fight to the end to promote his meth-
od as a framework to look at devia-
tions. He is the only person who ever
understood what I was saying.
Can you envisage a time when
trading and investment in general
takes a more realistic view on out-
liers and how to incorporate them
into models? If this occurs what will
the markets look like, won’t this cut
out so much noise that sustains the
industry? In such a world without
the GIF holding sway will everyone
be able to go home at the end of the
day less anxious because markets
have become less volatile as a result?
I do not know what it would do to
markets. But one day we will under-
stand the toxic side of beliefs (and
models). One day we will understand
Shackle’s point that economics and
human affairs are about epistemics,
the study of unknowledge. It will make
the world a better, and certainly safer,
place. Ciao.
W
Wilmott magazine