Category Archives: Papers

No, Small Probabilities are Not ‘Attractive to Sell’: A Comment by Nassim Taleb :: SSRN

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No, Small Probabilities are Not ‘Attractive to Sell’: A Comment
Nassim Nicholas Taleb
NYU-Poly
January 5, 2013
Financial Analysts Journal, Forthcoming

Abstract: Owing to the convexity of the payoff of out-of-the money options, an extremely small probability of a large deviation unseen in past data justifies rationally buying them, or at least justifies excessive caution in not being exposed to them, particularly those options that are extremely nonlinear in response to market movement or changes in implied volatility. One needs, for instance, a minimum of 2000 years of stock market data to assert that some tail options are “expensive”. The paper presents errors in Ilmanen 2012, which provides an exhaustive list of all arguments in favor of selling insurance on small probability events. The paper goes beyond Ilmanen 2012 and suggests an approach to analyze the payoff and risks of options based on the nonlinearities in the tails.
Number of Pages in PDF File: 5
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via No, Small Probabilities are Not ‘Attractive to Sell’: A Comment by Nassim Taleb :: SSRN.

Mathematical Definition, Mapping, and Detection of AntiFragility by Nassim Taleb, Raphael Douady :: SSRN

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Abstract: We provide a mathematical definition of fragility and antifragility as negative or positive sensitivity to a semi-measure of dispersion and volatility a variant of negative or positive “vega” and examine the link to nonlinear effects. We integrate model error and biases into the fragile or antifragile context. Unlike risk, which is linked to psychological notions such as subjective preferences (hence cannot apply to a coffee cup we offer a measure that is universal and concerns any object that has a probability distribution whether such distribution is known or, critically, unknown).

We propose a detection of fragility, robustness, and antifragility using a single “fast-and-frugal”, model-free, probability free heuristic that also picks up exposure to model error. The heuristic lends itself to immediate implementation, and uncovers hidden risks related to company size, forecasting problems, and bank tail exposures it explains the forecasting biases. While simple to implement, it outperforms stress testing and other such methods such as Value-at-Risk.

via Mathematical Definition, Mapping, and Detection of AntiFragility by Nassim Taleb, Raphael Douady :: SSRN.

A New Heuristic Measure of Fragility and Tail Risks: Application to Stress Testing by Nassim Taleb…

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Abstract:

This paper presents a simple heuristic measure of tail risk, which is applied to individual bank stress tests and to public debt. Stress testing can be seen as a first order test of the level of potential negative outcomes in response to tail shocks. However, the results of stress testing can be misleading in the presence of model error and the uncertainty attending parameters and their estimation. The heuristic can be seen as a second order stress test to detect nonlinearities in the tails that can lead to fragility, i.e., provide additional information on the robustness of stress tests. It also shows how the measure can be used to assess the robustness of public debt forecasts, an important issue in many countries. The heuristic measure outlined here can be used in a variety of situations to ascertain an ordinal ranking of fragility to tail risks.

Number of Pages in PDF File: 24

Keywords: Stress Testing, Forecasting, Stability

via A New Heuristic Measure of Fragility and Tail Risks: Application to Stress Testing by Nassim Taleb, Elie Canetti, Tidiane Kinda, Elena Loukoianova, Christian Schmieder :: SSRN.

Nassim Taleb Explains In An IMF Paper Why The Fed’s And ECB’s Bank Stress Tests Are Bogus – Business Insider

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A New Heuristic Measure of Fragility and Tail Risks: Application to Stress Testing Abstract Pdf

A better approach, according to Taleb and his IMF co-authors Elie Canetti, Tidiane Kinda, Elena Loukoianova, and Christian Schmeider, is to measure the difference between outcomes arising from different scenarios instead of focusing on the estimates of potential losses themselves.

According to Taleb, this is the real way to measure the “fragility” of a bank or a country in the event of a negative economic shock. Because point estimates are so prone to errors from faulty model assumptions, measuring the distance between them to detect how quickly losses pile up as the economic shock gets larger becomes a vastly more reliable measure of risk.

In other words, it’s not the size of the losses themselves that is important. Instead, it’s the rate of change of potential losses as the economic situation deteriorates that determines how fragile a bank is, by Taleb’s standards.

via Nassim Taleb Explains In An IMF Paper Why The Fed’s And ECB’s Bank Stress Tests Are Bogus – Business Insider.