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What is a Black Swan Event?

Posted by Robert Ruth on Friday, May 15th, 2020 at 10:10am.

black swan

Black Swans are circumstances that take civilization completely off guard because they occur with an extreme element of surprise.  The source of these events often is not knowable and the frequency and duration of a Black Swan cannot be reliably predicted.

In the world of finance and economics, a Black Swan is the term given to an event which is impossible to predict in advance and that has extremely negative consequences for an economy. The author Nassim Nicholas Taleb, a former Wall Street trader, summarized the nature of these events in his 2007 book “The Black Swan”:

"First, it is an outlier … outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme 'impact.' Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable."

So, a Black Swan event is one that occurs in a completely random fashion, with catastrophic impacts felt across many segments, that cannot be adequately explained. The financial crisis, coupled with the collapse of the housing market in 2008, was a widely cited example of a Black Swan event.  

There have been other Black Swan events, among the ones most commonly cited are: The September 11 attacks, World War I, the breakup and collapse of the Soviet Union, the sinking of the Titanic, and the 2001 dot-com bubble and crash.

In the financial sector, Black Swan events can inflict significant damage to an economy, due to the fact that they cannot be predicted accurately, and thus there is not a sufficient way to mitigate the impact caused by an unforeseen future event. 

The impact of this Coronavirus has been felt globally on both the personal and financial level, and the breadth and severity of this situation is still evolving. The shocks to our economy from this event are obvious: in less than two months, the United States economy has gone from full employment to a 14.7% unemployment rate, a change that is unparalleled in the history of this country. The extreme volatility in the stock market, coupled with the sizable historic intervention taken by the Federal Reserve to maintain market functioning and liquidity, has also been unprecedented in scale. 

These shocks, while caused by Covid-19, are actually short-term reactions to the situation we have found ourselves in. It remains to be seen what the longer-term implications of this event will be on our economy. The duration of the economic dislocation, both here and abroad, and how long it takes to recover from this Black Swan are simply not yet known. Given the global nature of this virus, and the economic shocks caused in the reaction of governments to mitigate the spread of the virus, the Covid-19 pandemic meets the criteria for a Black Swan.

 

Robert Ruth

Senior Mortgage Banker

NMLS#: 513243

Phone: 401.789.4441

ruthro19@outlook.com

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