Fear of a ‘Black Swan’ Event Is Worse Than the Actual Event Itself, Study Shows
first published in The Street | May 3, 2016

Sometimes fear of a freak, outlier event can be a lot worse than the event itself, at least when it comes to the markets.

Most of us are aware of the now famous credit crisis book by Nassim Nicholas Taleb, “The Black Swan: The Impact of the Highly Improbable.” The central thesis of the book is of course that black swans, or freak market events, are more common than we expect in life, and in particular, in complex systems such as economics. The credit crisis was, therefore, no great surprise, and such crises can be expected to occur in one form or another on a fairly regular basis.

Well, that was Taleb’s thesis. But it was also a thesis written at the height of negative market sentiment.

Subsequent serious academic work reported by Bloomberg by William Goetzmann, Dasol Kim and Robert Shiller looked at 26 years of survey data to test Taleb’s thesis.

They found that people consistently expect things such as stock market crashes and earthquakes to happen more frequently than they really do. In other words, there may be black swans out there, but more important perhaps than their occurrence is our exaggerated fear of their occurrence.

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There are indeed periods of irrational exuberance when we forget about the possibility of black swans.

But certainly since the credit crisis, it seems that there has indeed been an exaggerated angst that has gripped the global investing community. It is as if the crisis was sufficiently intense that it set off a type of Post-Traumatic Stress Disorder among investors, leading to everyone seeing specters around every corner.

This overarching sense of angst has had very significant effects since the credit crisis. Although there has been modest growth in gross domestic product in the United States ever since 2009, the recovery hasn’t felt like a recovery.

We continue to suffer what economist Joseph Stiglitz calls the “great malaise,” a lack of those animal commercial spirits.

Shiller himself sees this anxiety as driving this very low rate environment as most investors and banks keep the bulk of their assets in low-return fixed-income assets, which itself further lowers the yield on said assets.

This has also driven excess regulation.

No one can say that the credit crisis didn’t merit a significant re-think of various parts of the U.S. financial regulatory architecture. But it is now becoming equally clear that the Dodd-Frank Act was a behemoth of a piece of legislation, 848 pages long, most of it with half-baked concepts that were left to be developed over time by sub-legislation.