It's rare for technical finance (distinguished from the popular, i.e., how-to-save-for-retirement or college finance genre) to cross over to the mainstream. However, Nassim Nicholas Taleb, former and future hedge fund manager, pulls it off with his bestseller "The Black Swan: the Impact of the Highly Improbable".
Black swans are creatures that no one imagined existed until they were discovered in Australia, and financial black swans are events, like 9/11 or Katrina or the iPod, that are both unforeseen and have a huge impact on markets. And we may be entering an era when black swans are multiplying.
Modern finance teaches that the risk and reward of any investment can be decomposed into a combination of simpler financial instruments. For example, owning a stock is equivalent to owning a mix of nearly riskless Treasury bills and highly risky call options. Mr. Taleb suggests that it might be safer to put the bulk of one's funds in Treasuries and invest a small portion of one's portfolio in puts and calls, corresponding to "bad" and "good" black swans that are by definition unforeseen. The options are likely not to pay off and may even be written off completely, but if and when the unforeseen occurs the returns are huge. Meanwhile, most of one's nest egg is safe and is earning a low rate of interest.
I accept what he says intellectually, but I have great difficulty accepting what he says emotionally and organizing my investments this way. Which is why I'm not the author of a best-seller or leading the life of a hedge-fund manager. © 2007 Stephen Yuen
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