The Black Swan: The Impact of the Highly Improbable

In the group was a gentleman who ran a group of professional gamblers and who was banned from most casinos. He had come to share his wisdom with us. He sat not far from a stuffy professor of political science, dry like a bone and, as is characteristic of “big names,” careful about his reputation, who said nothing out of the box, and who did not smile once. During the sessions, I tried to imagine the hotshot with a rat dropped down his back, putting him in a state of wriggling panic. He was perhaps good at writing Platonic models of something called game theory, but when Laurence and I went after him on his improper use of financial metaphors, he lost all his arrogance.

Now, when you think of the major risks casinos face, gambling situations come to mind. In a casino, one would think, the risks include lucky gamblers blowing up the house with a series of large wins and cheaters taking away money through devious methods. It is not just the general public that would believe so, but the casino management as well. Consequently, the casino had a high-tech surveillance system tracking cheaters, card counters, and other people who try to derive an advantage over them. Each of the participants gave his presentation and listened to those of the others. I came to discuss Black Swans, and I intended to tell them that the only thing I know is that we know precious little about them, but that it was their property to sneak up on us, and that attempts at Platonifying them led to additional misunderstandings. Military people can understand such things, and the idea became recently prevalent in military circles with the expression unknown unknown (as opposed to the known unknown). But I had prepared my talk (on five restaurant napkins, some stained) and was ready to discuss a new phrase I coined for the occasion: the ludic fallacy. I intended to tell them that I should not be speaking at a casino because it had nothing to do with uncertainty.

The Uncertainty of the Nerd

What is the ludic fallacy? Ludic comes from ludus, Latin for games.

I was hoping that the representatives of the casino would speak before me so I could start harassing them by showing (politely) that a casino was precisely the venue not to pick for such a discussion, since the class of risks casinos encounter are very insignificant outside of the building, and their study not readily transferable. My idea is that gambling was sterilized and domesticated uncertainty. In the casino you know the rules, you can calculate the odds, and the type of uncertainty we encounter there, we will see later, is mild, belonging to Mediocristan. My prepared statement was this: “The casino is the only human venture I know where the probabilities are known, Gaussian (i.e., bell-curve), and almost computable.” You cannot expect the casino to pay out a million times your bet, or to change the rules abruptly on you during the game—there are never days in which “36 black” is designed to pop up 95 percent of the time.[27]

In real life you do not know the odds; you need to discover them, and the sources of uncertainty are not defined. Economists, who do not consider what was discovered by noneconomists worthwhile, draw an artificial distinction between Knightian risks (which you can compute) and Knightian uncertainty (which you cannot compute), after one Frank Knight, who rediscovered the notion of unkown uncertainty and did a lot of thinking but perhaps never took risks, or perhaps lived in the vicinity of a casino. Had he taken economic or financial risks he would have realized that these “computable” risks are largely absent from real life! They are laboratory contraptions!

Yet we automatically, spontaneously associate chance with these Platonified games. I find it infuriating to listen to people who, upon being informed that I specialize in problems of chance, immediately shower me with references to dice. Two illustrators for a paperback edition of one of my books spontaneously and independently added a die to the cover and below every chapter, throwing me into a state of rage. The editor, familiar with my thinking, warned them to “avoid the ludic fallacy,” as if it were a well-known intellectual violation. Amusingly, they both reacted with an “Ah, sorry, we didn’t know.”