Author: Slavica Grabovac
Publication date: 18.12.2023
For an event, to be qualified as a „Black Swan“, it has to fulfill these requirements:
1. it is an outlier
2. it carries a huge impact
3. it becomes explainable only after it has happened
Black swans' appearance has the potential to cause extensive harm on an economy, adversely affecting markets and investments. Despite the application of robust models, preventing a black swan event remains very difficult.
This term gained attention through Nassim Nicholas Taleb's book, "The Black Swan." In the 16th century, it was believed that all the swans were white. Explorers in Australia discovered black swans and the term is now used to refer to events that happened even though it seemed impossible.
Black Swan events in the history
Dot com bubble burst
The substantial rise and subsequent decline of internet firms in the late 1990s resulted in a sudden economic collapse.
At the time, the internet was in its early stages of commercial use. Investment funds poured their capital into technology companies with exaggerated valuations and minimal market success. As these companies went bankrupt, investment funds faced losses. Then they transferred risk to the investors. The novelty of the digital frontier made predicting the collapse nearly impossible.
2008 financial crisis
Initiated by the downfall of the US blooming housing market, it started a global banking crisis and a profound worldwide economic crisis.
The problems started after a period of consistent expansion following the dot-com bubble at the beginning of the century. Interest rates declined more than 4% between 2001 and 2008. This means that abundance of "easy money" was accessible to both individuals and businesses.
What's more, driven by the encouragement of the federal government, U.S. lenders considerably eased their criteria for mortgage qualification. Individuals were granted mortgages for homes well beyond their financial means. As a result, the subprime mortgages became a big balloon that was just waiting to burst. So, the lending company Lehman Brothers started to collapse.
COVID – 19 pandemic
In the newer history, we can look at the COVID 19 pandemic. It is an unprecedented global health crisis that had a big impact on global markets in 2020.
It satisfies all the criteria outlined by Taleb for a Black Swan event. We can say that no country was adequately prepared to confront it. As a consequence we can emphasize the downtrend in GDP, stock market and unemployment rates.
Apparently, there were many more Black Swan events in history, such as the outbreak of WW1, 9/11 in the US and the Indian Ocean earthquake. We explained the events listed above because they are more directly connected with financial markets.
Black Swan events in the future
As previously mentioned, black swans, by their very definition, are not predictable. However, we can try to limit its impact and reduce the vulnerabilities of our environment.
To maximize the resilience of our environment, we can follow this 4 steps:
Learn
Acquire knowledge from past events
Reply
Know what to do when something happens (follow the previous practice or adapt fast to new situation)
Monitor
Be vigilant to recognize early signs of change and take preemptive measures to prevent potential issues
Anticipate
Have ability to predict what may happen in the future and what effect it will have on the system
When we look at the future, a potential candidate for the next Black Swan event is a cyber-physical incident. This is addressed to a disruption caused by a cyber attack on essential infrastructure, for example, the electrical grid, transportation systems, or financial systems. Such an attack has the potential to compromise services and exploit vulnerabilities, whether known or unknown.
Takeaways
To be ready for a potential cyber-physical event, it's crucial to establish strong cybersecurity protocols. Besides that, we need to educate personnel on responding to cyber attacks and prioritize investments in resilience. This involves funding technology and infrastructure, crafting contingency plans, and preparing for worst-case scenarios.