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nntaleb: Finished My Central Paper http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1669317

nntaleb: Finished My Central Paper http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1669317

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Convexity, Robustness, and Model Error
Nassim Nicholas Taleb

NYU-Poly
August, 31 2010
Abstract:
This discussion makes the distinction inside the Fourth Quadrant “Black Swan Domain” between fragile an robust to model (or representational) error on the basis of convexity.
• The notion of model error as a convex or concave stochastic variable.
• Why deficit forecasting errors are biased in one direction.
• Why large is fragile to errors.
• How economics as a discipline made the monstrously consequential mistake of treating estimated parameters as nonstochastic variables and why this leads to fat-tails even while using Gaussian models.
• The notion of epistemic uncertainty as embedded in model errors.
In addition, it introduces a simple practical heuristic to measure (as an indicator of fragility) the sensitivity of a portfolio (or balance sheet) to model error. Finally, it sets an explicit path to conduct policy based on robustness

Working Paper Series

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