No black tulip bulbs, no black swans

December 10, 2008

The world has experienced many crises in the past.

In 1636, during the Dutch Tulip Bulb Bubble, the quest for a perfect black bulb had inflated the price of a black bulb by many hundreds. In a different crisis in 1866, a London wholesale bank Overend, Gurney & Co collapsed with a massive debt, after expanding its investment portfolio beyond its means.

What is common in these events and the present crisis is that investors borrowed and levered themselves, and the eventual bubble burst prompted massive deleveraging and contagion, according to Julian Chillingworth, chief investment officer at London-based asset management firm Rathbones (established in 1742 – 22 years after the South Sea Bubble).

“It’s greed, it’s fear and it’s leverage,” Chillingworth told a group of journalists at a breakfast briefing. He says all the risky and highly leveraged assets were dressed up with “pseudo finance” and the likelihood of contagion and volatility was characterised as a “black swan” event – originally a metaphor for something that could not exist.

But black swans do exist. Just as people in the 17th century reached Australia and found black swans, investors have learned the hard lesson this time.

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To all mathematicians save one currently popular one, the phrase “black swan” has always meant the exact opposite of what it now means in the press.

A black swan was a idle curiosity: something had no reason not to exist, and whose nonexistence could only be proved by exhaustive enumeration; conversely, the discovery that such did creatures did exist would not require any rule books to be thrown out, and would only appear to be a major scientific discovery to non-scientists.

I believe the “black swan problem” is discussed in Russell’s Principia.

Posted by Ian Kemmish | Report as abusive