What is a Black Swan Event?
A Black Swan Event is a metaphor describing a rare, unexpected phenomenon with a low probability of occurrence, yet has a significant impact on society as a whole.
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What is the Black Swan Event Theory?
The term “Black Swan Event” – popularized by Nassim Nicholas Taleb – refers to unpredictable occurrences, often with catastrophic consequences.
According to Taleb, the three traits of a black swan event are:
- Rarity – i.e. Unpredictable Outlier
- Results in Severe Consequences
- Rationalized Post-Occurrence – i.e. Retrospective Bias
Excerpt from The Black Swan by Nassim Taleb (Source: The Black Swan)
How Does a Black Swan Event Work?
In the context of the stock market, the underlying idea behind the so-called “Black Swan Theory” is not to predict such improbable events, but rather to be more strategic in terms of capital allocation and risk mitigation.
Even if such events can occur, there must be measures already set in place to limit possible losses and the downside risk, or perhaps even profit from the events, if well-positioned (i.e. tail risk hedging).
Therefore, the investment strategy entails minimizing losses while placing bets to capitalize on irregular events, akin to a venture capitalist in pursuit of “home runs” to offset potential losses.
In the case of investing and trading in the financial markets, a few examples of risk measures include:
- Portfolio Diversification (e.g. Industry, Geography)
- Avoidance of Portfolio Concentration (e.g. Portfolio Diversification)
- Hedges (e.g. Options, Derivatives)
What are Examples of Black Swan Events in the Stock Market?
Despite the association with events with significantly negative impacts, black swan events are not all crises, per se. The following list contains examples of notable black swan events:
- Digital Age (“Dot Com” Era) – i.e. Rise of the Internet, Adoption of Personal Computing, Mobile Phones
- Terrorist Attacks on September 11, 2001
- 2008 Global Financial Crisis – i.e. the “Great Recession”
The “dot com” era consisted of a recession once the bubble popped.
Still, despite the initial sell-off, the U.S. eventually emerged with prominent companies, most notably Amazon.
The development of the eCommerce sector led by Amazon is one example of a “positive” black swan event.
In other words, the interpretation depends on the perspective and information on hand for whether an event is classified as a “Black Swan” event or not – i.e. one person’s loss is another’s gain.
