Taleb, Nassim Nicholas.
Antifragile.
New York: Random House, 2012.
ISBN 978-0-8129-7968-8.
This book is volume three in the author's
Incerto series, following
Fooled by Randomness (February 2011) and
The Black Swan (January 2009).
It continues to explore the themes of randomness, risk,
and the design of systems: physical, economic, financial,
and social, which perform well in the face of uncertainty
and infrequent events with large consequences. He begins by
posing the deceptively simple question, “What is the
antonym of ‘fragile’?”
After thinking for a few moments, most people will answer
with “robust” or one of its synonyms such as
“sturdy”, “tough”, or
“rugged”. But think about it a bit more: does
a robust object or system actually behave in the opposite
way to a fragile one? Consider a teacup made of fine china. It
is fragile—if subjected to more than a very limited amount
of force or acceleration, it will smash into bits. It is
fragile because application of such an external stimulus, for
example by dropping it on the floor, will dramatically degrade
its value for the purposes for which it was created (you can't
drink tea from a handful of sherds, and they don't look good
sitting on the shelf). Now consider a teacup made of stainless
steel. It is far more robust: you can drop it from ten
kilometres onto a concrete slab and, while it may be slightly
dented, it will still work fine and look OK, maybe even acquiring
a little character from the adventure. But is this really the
opposite of fragility? The china teacup was degraded by the
impact, while the stainless steel one was not. But are there
objects and systems which improve as a result of random
events: uncertainty, risk, stressors, volatility, adventure,
and the slings and arrows of existence in the real world? Such
a system would not be robust, but would be genuinely
“anti-fragile” (which I will subsequently write
without the hyphen, as does the author): it welcomes these
perturbations, and may even require them in order to function
well or at all.
Antifragility seems an odd concept at first. Our experience is
that unexpected events usually make things worse, and that
the inexorable increase in entropy causes things to degrade
with time: plants and animals age and eventually die; machines
wear out and break; cultures and societies become decadent, corrupt,
and eventually collapse. And yet if you look at nature,
antifragility is everywhere—it is the mechanism which
drives biological evolution, technological progress, the
unreasonable effectiveness of free market systems in efficiently meeting
the needs of their participants, and just about
everything else that changes over time, from trends in art,
literature, and music, to political systems, and human
cultures. In fact, antifragility is a property of most
natural, organic systems, while fragility (or at best, some
degree of robustness) tends to characterise those which
were designed from the top down by humans. And one of the
paradoxical characteristics of antifragile systems is that
they tend to be made up of fragile components.
How does this work? We'll get to physical systems and finance
in a while, but let's start out with restaurants. Any
reasonably large city in the developed world will have a
wide variety of restaurants serving food from numerous
cultures, at different price points, and with ambience
catering to the preferences of their individual clientèles. The
restaurant business is notoriously fragile: the culinary
preferences of people are fickle and unpredictable, and
restaurants who are behind the times frequently go under.
And yet, among the population of restaurants in a given
area at a given time, customers can usually find what
they're looking for. The restaurant population
or industry is antifragile, even though it is
composed of fragile individual restaurants which come
and go with the whims of diners, which will be catered
to by one or more among the current, but ever-changing
population of restaurants.
Now, suppose instead that some Food Commissar in the
All-Union Ministry of Nutrition carefully studied the
preferences of people and established a highly-optimised
and uniform menu for the monopoly State Feeding Centres, then
set up a central purchasing, processing, and distribution
infrastructure to optimise the efficient delivery of these
items to patrons. This system would be highly fragile, since
while it would deliver food, there would no feedback
based upon customer preferences, and no competition to
respond to shifts in taste. The result would be a mediocre
product which, over time, was less and less aligned with
what people wanted, and hence would have a declining
number of customers. The messy and chaotic market of
independent restaurants, constantly popping into existence
and disappearing like virtual particles, exploring the culinary
state space almost at random, does, at any given moment,
satisfy the needs of its customers, and it responds to
unexpected changes by adapting to them: it is antifragile.
Now let's consider an example from metallurgy. If you
pour molten metal from a furnace into a cold mould, its
molecules, which were originally jostling around
at random at the high temperature of the liquid metal,
will rapidly freeze into a structure with small crystals
randomly oriented. The solidified metal will contain
dislocations wherever two crystals meet, with each
forming a weak spot where the metal can potentially
fracture under stress. The metal is hard, but brittle:
if you try to bend it, it's likely to snap. It is
fragile.
To render it more flexible, it can be subjected to the
process of
annealing,
where it is heated to a high temperature (but below melting),
which allows the molecules to migrate within the bulk of the
material. Existing grains will tend to grow, align, and merge,
resulting in a ductile, workable metal. But critically, once
heated, the metal must be cooled on a schedule which provides
sufficient randomness (molecular motion from heat) to allow the process
of alignment to continue, but not to disrupt already-aligned
crystals. Here is a video from
Cellular Automata Laboratory
which demonstrates annealing. Note how sustained randomness
is necessary to keep the process from quickly “freezing up”
into a disordered state.
In another document at this site, I discuss solving the
travelling
salesman problem through the technique of
simulated
annealing, which is analogous to annealing metal, and
like it, is a manifestation of antifragility—it doesn't
work without randomness.
When you observe a system which adapts and prospers in the
face of unpredictable changes, it will almost always do
so because it is antifragile. This is a large part of how
nature works: evolution isn't able to predict the future
and it doesn't even try. Instead, it performs a massively
parallel, planetary-scale search, where organisms, species,
and entire categories of life appear and disappear
continuously, but with the ecosystem as a whole constantly
adapting itself to whatever inputs may perturb it, be they
a wholesale change in the composition of the atmosphere
(the oxygen
catastrophe at the beginning of the Proterozoic eon
around 2.45 billion years ago), asteroid and comet
impacts, and ice ages.
Most human-designed systems, whether machines, buildings,
political institutions, or financial instruments, are the
antithesis of those found in nature. They tend to be
highly-optimised to accomplish their goals with the minimum
resources, and to be sufficiently robust to cope with any
stresses they may be expected to encounter over their
design life. These systems are not antifragile: while
they may be designed not to break in the face of unexpected
events, they will, at best, survive, but not, like
nature, often benefit from them.
The devil's in the details, and if you reread the last paragraph
carefully, you may be able to see the horns and pointed tail
peeking out from behind the phrase “be expected to”.
The problem with the future is that it is full of all kinds of
events, some of which are un-expected, and whose consequences
cannot be calculated in advance and aren't known until they
happen. Further, there's usually no way to estimate their
probability. It doesn't even make any sense to talk about the
probability of something you haven't imagined could happen.
And yet such things happen all the time.
Today, we are plagued, in many parts of society, with
“experts”
the author dubs fragilistas. Often equipped with
impeccable academic credentials and with powerful mathematical
methods at their fingertips, afflicted by the
“Soviet-Harvard delusion” (overestimating the scope
of scientific knowledge and the applicability of their modelling
tools to the real world), they are blind to the unknown and
unpredictable, and they design and build systems which are
highly fragile in the face of such events. A characteristic of
fragilista-designed systems is that they produce small, visible,
and apparently predictable benefits, while incurring invisible
risks which may be catastrophic and occur at any time.
Let's consider an example from finance. Suppose you're a
conservative investor interested in generating income from
your lifetime's savings, while preserving capital to pass
on to your children. You might choose to invest, say, in a
diversified portfolio of stocks of long-established companies
in stable industries which have paid dividends for 50 years
or more, never skipping or reducing a dividend payment.
Since you've split your investment across multiple
companies, industry sectors, and geographical regions,
your risk from an event affecting one of them is
reduced. For years, this strategy produces a reliable
and slowly growing income stream, while appreciation of
the stock portfolio (albeit less than high flyers
and growth stocks, which have greater risk and pay small
dividends or none at all) keeps you ahead of inflation.
You sleep well at night.
Then 2008 rolls around. You didn't do anything wrong.
The companies in which you invested didn't do anything
wrong. But the fragilistas had been quietly building
enormous cross-coupled risk into the foundations of the
financial system (while pocketing huge salaries and
bonuses, while bearing none of the risk themselves), and
when it all blows up, in one sickening swoon, you find
the value of your portfolio has been cut by 50%. In a
couple of months, you have lost half of what you worked
for all of your life. Your “safe, conservative, and
boring” stock portfolio happened to be correlated with
all of the other assets, and when the foundation of the
system started to crumble, suffered along with them. The
black swan landed on your placid little pond.
What would an antifragile investment portfolio look like, and
how would it behave in such circumstances? First, let's briefly
consider a financial
option. An
option is a financial derivative contract which gives the
purchaser the right, but not the obligation, to buy (“call
option”) or sell (”put option”) an underlying
security (stock, bond, market index, etc.) at a specified price,
called the “strike price” (or just “strike”).
If the a call option has a strike above, or a put option a strike
below, the current price of the security, it is called “out
of the money”, otherwise it is “in the money”.
The option has an expiration date, after which, if not
“exercised” (the buyer asserts his right to buy
or sell), the contract expires and the option becomes worthless.
Let's consider a simple case. Suppose Consolidated Engine Sludge
(SLUJ) is trading for US$10 per share on June 1, and I buy a call
option to buy 100 shares at US$15/share at any time until
August 31. For this right, I might pay a premium of, say,
US$7. (The premium depends upon sellers' perception of the
volatility of the stock, the term of the option, and the
difference between the current price and the strike price.)
Now, suppose that sometime in August, SLUJ announces a
breakthrough that allows them to convert engine sludge into
fructose sweetener, and their stock price soars on the news
to US$19/share. I might then decide to sell on the news,
exercise the option, paying US$1500 for the 100 shares, and
then immediately sell them at US$19, realising a profit of US$400
on the shares or, subtracting the cost of the option, US$393
on the trade. Since my original investment was just US$7, this
represents a return of 5614% on the original investment, or
22457% annualised. If SLUJ never touches US$15/share, come
August 31, the option will expire unexercised, and I'm out the
seven bucks. (Since options can be bought and sold at any
time and prices are set by the market, it's actually a bit
more complicated than that, but this will do for understanding
what follows.)
You might ask yourself what would motivate somebody to sell such
an option. In many cases, it's an attractive proposition. If
I'm a long-term shareholder of SLUJ and have found it to be a
solid but non-volatile stock that pays a reasonable dividend of,
say, two cents per share every quarter, by selling the call
option with a strike of 15, I pocket an immediate premium of
seven cents per share, increasing my income from owning the
stock by a factor of 4.5. For this, I give up the right to any
appreciation should the stock rise above 15, but that seems to
be a worthwhile trade-off for a stock as boring as SLUJ (at
least prior to the news flash).
A put option is the mirror image: if I bought a put on SLUJ with a
strike of 5, I'll only make money if the stock falls below 5
before the option expires.
Now we're ready to construct a genuinely antifragile investment.
Suppose I simultaneously buy out of the money put and call
options on the same security, a so-called
“long
straddle”. Now, as long as the price remains within the
strike prices of the put and call, both options will expire
worthless, but if the price either rises above the call strike
or falls below the put strike, that option will be in the money
and pay off the further the underlying price veers from the
band defined by the two strikes. This is, then, a pure bet on
volatility: it loses a small amount of money as long as nothing
unexpected happens, but when a shock occurs, it pays off
handsomely.
Now, the premiums on deep out of the money options are usually
very modest, so an investor with a portfolio like the one I
described who was clobbered in 2008 could have, for a small sum
every quarter, purchased put and call options on, say, the
Standard & Poor's 500 stock index, expecting to usually have
them expire worthless, but under the circumstance which halved
the value of his portfolio, would pay off enough to compensate
for the shock. (If worried only about a plunge he could, of
course, have bought just the put option and saved money on
premiums, but here I'm describing a pure example of
antifragility being used to cancel fragility.)
I have only described a small fraction of the many topics
covered in this masterpiece, and described none of the
mathematical foundations it presents (which can be skipped by
readers intimidated by equations and graphs). Fragility and
antifragility is one of those concepts, simple once understood,
which profoundly change the way you look at a multitude of
things in the world. When a politician, economist, business
leader, cultural critic, or any other supposed thinker or expert
advocates a policy, you'll learn to ask yourself, “Does
this increase fragility?” and have the tools to answer the
question. Further, it provides an intellectual framework to
support many of the ideas and policies which libertarians and
advocates of individual liberty and free markets instinctively
endorse, founded in the way natural systems work. It is
particularly useful in demolishing “green” schemes
which aim at replacing the organic, distributed, adaptive, and
antifragile mechanisms of the market with coercive, top-down,
and highly fragile central planning which cannot possibly have
sufficient information to work even in the absence of unknowns
in the future.
There is much to digest here, and the ramifications of some of
the clearly-stated principles take some time to work out and
fully appreciate. Indeed, I spent more than five years reading
this book, a little bit at a time. It's worth taking the time
and making the effort to let the message sink in and figure out
how what you've learned applies to your own life and act
accordingly. As Fat Tony says, “Suckers try to win
arguments; nonsuckers try to win.”
