The black swan event is a metaphor that describes an event that comes as a surprise, has a major effect, and is often inappropriately rationalized after the fact with the benefit of hindsight. The term is based on an ancient saying that presumed black swans did not exist – a saying that became reinterpreted to teach a different lesson after the first European encounter with them.
A black swan event, a phrase commonly used in the world of finance, is an extremely negative event or occurrence that is impossibly difficult to predict. In other words, black swan events are events that are unexpected and unknowable.
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The black swan event can be explained by:
The disproportionate role of high-profile, hard-to-predict, and rare events that are beyond the realm of normal expectations in history, science, finance, and technology.
The non-computability of the probability of consequential rare events using scientific methods (owing to the very nature of small probabilities).
The psychological biases that blind people, both individually and collectively, to uncertainty and a rare event's massive role in historical affairs.
A black swan event refers to unexpected events of large magnitude and consequence and their dominant role in history.
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Attributes of Black Swan Events
Taleb outlined the three defining attributes of a black swan event:
An event that is unpredictable.
A black swan event results in severe and widespread consequences.
After the occurrence of a black swan event, people will rationalize the event as having been predictable (known as the hindsight bias).
Example of a Black Swan Event
For example, the imposition of a steel and aluminum tariff by the President of the United States may be considered a black swan event. Companies that export steel and aluminum to the United States, namely those located in Canada, Mexico, and Brazil, were not expecting such an announcement by the US President.
Understanding the Black Swan
Although black swan events seem to come with a negative connotation, the concept does not only apply to negative events. Whether the event is positive or negative depends on the perspective of the individual.
For example, a disastrous day in the stock market may be seen as a positive event for an investor with aggressive short positions but a negative event for an investor who has heavily bought into the market.
Real-life Examples
Throughout history, there have been several notable black swan events. Here are five prominent ones from the finance world:
1. The 1997 Asian Financial Crisis
The Asian financial crisis in 1997 was a series of currency devaluations that spread throughout several Asian markets, starting when Thailand unpegged the baht to the US dollar. As a result of the ensuing crisis, Asian currencies dropped by as much as 38% and international stocks declined by nearly 60%.
2. The “Dotcom” Crash
Due to the rapid growth in internet usage in the 1980s and 1990s, many internet companies were launched. However, a lot of these companies failed after some time. In addition, many of those that were successful were severely overvalued. From 2000 to 2002, several internet companies crashed, resulting in significant losses for investors. The dotcom crash wiped out nearly a trillion dollars worth of stock value. The NASDAQ Composite lost 78% of its value in the dotcom crash.
3. 9/11 Attacks
The attack on the Twin Towers of New York’s World Trade Center prompted the closure of the NYSE and NASDAQ on the morning of September 11, 2001. Stocks plummeted during the first trading week after 9/11 – $1.4 trillion in stock market value was lost within a week.
4. The 2008 Global Financial Crisis
The global financial crisis in 2008 caused Lehman Brothers to file for bankruptcy – the largest bankruptcy filing in US history. Over 25,000 Lehman employees went jobless and more than $46 billion of Lehman’s market value was wiped out. In total, over $10 trillion was eventually wiped out in the global equity markets.
5. Brexit
In June 2016, news of the British referendum’s decision to leave the European Union caught many by surprise. It caused the British pound to sharply drop to a 31-year low against the US dollar. The Brexit vote wiped out nearly $2 trillion of value in global markets.
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