Emi Gal

Emi Gal

13-11-2021

22:22

I finished @nntaleb's Real World Risk Institute (#RWRI) two-week program this past week, and it was one of the most insightful, intellectually challenging, and fun learning experiences I've had in a long time. Here's a thread with 10 very practical things I learned ๐Ÿงต

1. Most real-world risk comes from fat tails. WTF is a fat tail? A fat-tailed system is one that is governed by a power law distribution (as opposed to a gaussian distribution). In a fat-tailed system, one single event drives all the outcomes.

Here's an example: Let's say 100 people are reading this tweet. The average height of the 100 people reading this tweet is 5'4". If LeBron James starts reading this tweet as well, the average height doesn't change much. Maybe it's now 5'5".

But let's look at the wealth of these 100 tweet readers. The average wealth of 100 people reading this tweet is, say $150k. But if Jeff Bezos somehow starts reading this as well (hi, Jeff!), the average wealth goes up to $1B. That's a power law. One event changes everything.

2. In a non-linear / fat-tailed system, it's important to be convex, not concave. Convexity = positively exposed to an extreme event; think of a ๐Ÿ™‚. Concavity = negatively exposed to an extreme event; think of a โ˜น๏ธ. It's better to be convex than to be smart.

3. Ok, but how do you know if you're concave or convex? The genius 1+a / 1-a rule. Say you have $100 in a portfolio and calculate that if the market goes up by 10% (1+a) you have $110, but if the market goes down by 10% (1-a), you have $75. You're obviously concave.

4. Concavity leads to ruin, and to protect yourself from ruin you should apply the *barbell strategy*. WTF is the barbell strategy? Put 90% of your stuff in safe stuff (e.g. cash), and 10% of your stuff in risky investments (e.g. crypto - sorry Nassim!)

5. Ok, but how about convexity you ask. You want to be convex, right? Two strategies: a) tinker + trial & error: how do you end up with better spaghetti carbonara? By having a bunch of food lovers try various recipes, or by having chemists design one? I know which one I'd eat

b) expose yourself to 1/N. If 1 event drives all outcomes, you have to be exposed to that 1 event. So - own a portfolio of things. Don't put all your eggs in one basket.

6. Assess risk by optimizing for sleeping well at night. Sleeping well gives you a 6th sense. Not sleeping well? You probably have too much risk somewhere. Clip your risk.

7. You've heard that correlation is not causation, right? Well - guess what. Correlation is actually not correlation. Here's a good heuristic for that statement: take your grandma's blood pressure and you can probably find a stock that correlates with it.

8. Volatility is good, as volatile things are more antifragile. As crazy as it may seem, it's safer to be an Uber driver than an investment banker, as you're more adaptive to unforeseen events. The banker can get fired. The Uber driver can start doing Uber Eats if necessary.

9. Only the hyperparanoid survive. There *will* be a market drawdown, and if you haven't clipped your tail (aka mitigated your risks), you're ngmi.

10. My favorite heuristic from the whole program came in a session by @financequant: Community is the ultimate hedge. So in a way, #RWRI actually *is* the ultimate hedge - a community of real-world risk takers on a lifelong journey to take risks and learn from them.

Huge thank you to @nntaleb, @financequant, @normonics, @drcirillo, Raphael Douady and the rest of the #RWRI team for creating such an incredible program.


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