Black Swan Vs Grey Rhino

Financial markets have an uncanny fascination with animals and birds. We have all heard of doves and hawks that are the talk of the town in monetary policy meetings of most central banks. But let’s leave these flying birds for another day. Today, let’s talk about Black Swans and Grey Rhinos.

Black Swans and Grey Rhinos are associated with risk events. Speaking of risk, humans hardly understand it properly and rarely account for it in their decision making. 

Before making any decision, there are three factors that needs to be considered:

1. The known knowns – the ones we can calculate and analyse
2. The known unknowns – the ones we can estimate and try to predict
3. The unknown unknowns – the ones we cannot make head or tail of 

It’s these factors that pose the largest risk in any decision.

Black Swans

Black swan theory is essentially the study of the impact of unknown unknowns or even of unknowable unknowns.

Black Swan Events have certain distinguishing features:

First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility.

Second, it carries an extreme ‘impact.’

Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.

Put in simple terms:

1. A black swan event is unpredictable.
2. A black swan event results in severe and widespread consequences.
3. After the occurrence of a black swan event, people will rationalize the event as having been predictable (known as the hindsight bias).

The term goes back to the idea that in history swans were always associated with the colour white and a Black swan is extremely rare. 

So, by their very nature, black swan events are quite exclusive. They must be, because if next to everything is a black swan, then nothing is.

Grey Rhino

A Grey Rhino is a “highly probable, high impact yet neglected threat … grey rhinos are not random surprises but occur after a series of warnings and visible evidence,”

Grey Rhino is a two-tonne thing with its horns pointed our way and its massive weight bearing down on us. We’ve a choice to do something about it or not. It’s a metaphor for so many of the things that go wrong in business, in policy, and in our personal lives that are avoidable. We do not pay enough attention to the big obvious problems that are in front of us. 

The “Dotcom Crash” and the 2008 Global Financial Crisis are perfect examples of Grey Rhinos which came with adequate warnings, but no attention was paid to them which led to them snowballing into something so big.