A Fat Tail World – Part 1

By Ian Bremmer

Preston Keat and I have just written a book about the low-probability, high-impact events that we often fail to prepare for and which happen more often than you might think. Think of the “hundred-year storms” that now seem to roll through every few years — or the current global financial crisis. The book is called The Fat Tail: The Power of Political Knowledge in Strategic Investing and you can read more about it at www.fattailbook.com. Over the next couple of weeks, Preston and I will be writing in this space about what The Fat Tail tells us about the world we’re now living in. 

You may be familiar with Nassim Taleb’s book The Black Swan: The Impact of the Highly Improbable. Taleb is essentially talking about fat tails when he describes what he calls “black swans” — the phenomenon we assume is impossible only because we’ve never seen it before. As he points out, traditional market models tend to miss these seemingly improbable events, a problem I’ve discussed with him at length. Taleb — a mathematician, a formal modeler, and a trader — has noted that Wall Street models (both risk management tools and even underlying incentives for compensation) tend to be oriented toward the short-term and favor outcomes that have been recently observed and are easily measurable rather than a broader range of possibilities that includes events that are highly unlikely and potentially catastrophic. In other words, if there are risks out there that don’t easily fit the models, they tend to be ignored. Taleb’s focus is on the financial. He explains why we shouldn’t be surprised that the sub-prime crisis hit global markets in such dramatic fashion and why we should expect unforeseen disasters to occur with some regularity. Taleb concludes that future disasters will be equally frequent and unforeseeable. That’s certainly true…with present models, when applied to financial and economic risks. 

But the central point in “The Fat Tail” is that many of the underlying risks that now impact markets are fundamentally political, not economic, and can be understood utilizing political frameworks. This is increasingly true in developed industrial democracies as well as in emerging markets. 

The traditional risk-assessment models used by the financial sector — and most multinational corporations, for that matter — focus on more easily measurable economic factors. As a result, we’re going to see a growing disconnect in unforeseen risks to the global marketplace. It’spossible to better understand these risks using political frameworks. Even if many of them cannot be predicted, we can identify environments in which they are unusually likely to occur and help those who are exposed to them to develop plans to manage them. We delve into the various types of risk in detail, from the macro (geopolitical conflict, terrorism, revolution) to the micro (nationalizations, regulatory policy, etc). I’ll leave defining and assessing each of those types of risk for the book itself. 

These political risks are growing. In the next installment, I’ll explain why that is.