dmnieren

Black Swans, Real Estate and Financial Stocks

I'll give you a point that Taleb sets up a bit of a difficult argument to prove or disprove, but that's not really his point. His point would be your model --Citigroup's decline is a low-probability event (as defined by you of 1:40 years)--is not real. It does not and cannot accurately quantify the likelihood of a 45% decline in C's stock. Your probability is based on past returns which do not account for the unknowable black swan even of the future (i.e. Enron-style fraud, Spitzer-like gov't interference, or worse). Therefore, your "prediction" that such a return is only a 1:40 event is useless.

BUT the biggest nail in your silly probability coffin is that C had a >40% decline just 6 years ago in the August '01 to June '02 timeframe (less than a year; Black Swan=9/11). C had nearly a 50% decline from June -Sept '98 (Black Swan=Russia default). And another from June '90 to Oct. '90 (Black Swan=S&L?, Gulf War I?). And another from from Sept - Dec '87 (Black Swan=October '87 crash). And another from May '81 to March '82 (help me out on that one--interest rates?).

FIVE such declines in the past 25 years. This is not a 1:40 event. Period. That is what Taleb was hammering on. These probabilistic models always underestimate the "tails" because stock returns do not follow a standard bell curve.

By not correctly estimating your downside risk, you greatly increase the odds you'll get blown up. Period. That's one of the big themes in Taleb's work.