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http://ssrn.com/abstract=1850428
 
 

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The Future Has Thicker Tails than the Past: Model Error as Branching Counterfactuals


Nassim Nicholas Taleb


New York University-Poly School of Engineering

May 23, 2011

NYU Poly Research Paper

Abstract:     
Ex ante predicted outcomes should be interpreted as counterfactuals (potential histories), with errors as the spread between outcomes. But error rates have error rates. We reapply measurements of uncertainty about the estimation errors of the estimation errors of an estimation treated as branching counterfactuals. Such recursions of epistemic uncertainty have markedly different distributial properties from conventional sampling error, and lead to fatter tails in the projections than in past realizations. Counterfactuals of error rates always lead to fat tails, regardless of the probability distribution used. A mere .01% branching error rate about the STD (itself an error rate), and .01% branching error rate about that error rate, etc. (recursing all the way) results in explosive (and infinite) moments higher than 1. Missing any degree of regress leads to the underestimation of small probabilities and concave payoffs (a standard example of which is Fukushima). The paper states the conditions under which higher order rates of uncertainty (expressed in spreads of counterfactuals) alters the shapes the of final distribution and shows which a priori beliefs about conterfactuals are needed to accept the reliability of conventional probabilistic methods (thin tails or mildly fat tails).

Number of Pages in PDF File: 11

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Date posted: May 24, 2011  

Suggested Citation

Taleb, Nassim Nicholas, The Future Has Thicker Tails than the Past: Model Error as Branching Counterfactuals (May 23, 2011). NYU Poly Research Paper. Available at SSRN: http://ssrn.com/abstract=1850428 or http://dx.doi.org/10.2139/ssrn.1850428

Contact Information

Nassim Nicholas Taleb (Contact Author)
New York University-Poly School of Engineering ( email )
Brooklyn, NY 11201
United States

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