The dissenters

Classical finance has a favourite model: the bell curve. Most days are calm, and extreme days almost impossible.

Four thinkers spent their lives saying this model is wrong. Their ideas come back with every crisis.

The first is a mathematician, Benoît Mandelbrot. In the sixties, he studied cotton prices.

He saw that large moves happen far more often than the bell predicts. The edges of the curve are fat.

On the nineteenth of October nineteen eighty-seven, the Dow Jones lost nearly twenty-three per cent in a day. For the bell, that is almost impossible.

Mandelbrot added an idea: prices are fractal. Over a day or over ten years, the curve has the same jagged look.

The second is an American economist, Hyman Minsky. His idea fits in one sentence: stability breeds instability.

When all goes well for a long time, people forget risk. They borrow a little more, then much more.

Minsky described three stages. First, you repay from your income. Next, you only pay the interest.

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Finally, you count on rising prices to pay for everything. Minsky called this stage Ponzi finance.

The day prices stop rising, everything turns at once. Since then, this has been called a Minsky moment.

Minsky died in nineteen ninety-six. In two thousand eight, everyone was rereading his books.

The third is an investor, George Soros. His idea is called reflexivity.

Prices do not just reflect reality, they change it. A rising share helps the company raise money, and so grow.

Belief changes the facts, and the facts reinforce the belief. That is how bubbles are born, and crashes.

In nineteen ninety-two, Soros bet against the pound sterling. It left the European exchange rate system, and he made about one billion dollars.

The fourth is Nassim Taleb, a former trader turned essayist. He made the black swan famous: the rare, unforeseen, huge event.

Then he went further. The opposite of fragile is not solid. It is antifragile: what grows stronger under shocks.

A glass breaks when you shake it. A muscle grows stronger when you work it.

For a portfolio, Taleb proposes the barbell. For the example: ninety per cent very cautious, ten per cent very risky.

Out of ten thousand euros, if the cautious part does not move, the worst is known: nine thousand euros remain. The best has no ceiling.

Four voices, one message. Models are useful, but the real world has more extremes than they say.

So keep a margin. And beware of debt that forces you to sell at the worst moment.

Prefer what survives surprises to what only works if everything goes to plan.