Archive for April, 2009

Dinosaurs and Tail Risk

Writing in this morning’s FT, Nassim Nicholas Taleb proposes Ten principles for a Black Swan-proof world:

1. What is fragile should break early while it is still small. Nothing should ever become too big to fail. Evolution in economic life helps those with the maximum amount of hidden risks – and hence the most fragile – become the biggest.

Then we will see an economic life closer to our biological environment: smaller companies, richer ecology, no leverage.

A sensible plan, but unfortunately Mr. Taleb’s faith in biology is misplaced.

Why the Dinosaurs got so Large

19th-century palaeontologist Edward Drinker Cope noticed that animal lineages tend to get bigger over evolutionary time, starting out small and leaving ever bigger descendants. This process came to be known as Cope’s rule.

Getting bigger has evolutionary advantages, explains David Hone, an
expert on Cope’s rule at the Institute of Vertebrate Paleontology and
Paleoanthropology in Beijing, China. “You are harder to predate and it
is easier for you to fight off competitors for food or for mates.” But
eventually it catches up with you. “We also know that big animals are
generally more vulnerable to extinction,” he says. Larger animals eat
more and breed more slowly than smaller ones, so their problems are
greater when times are tough and food is scarce. “Many of the very
large mammals, such as Paraceratherium, had a short tenure in the
fossil record, while smaller species often tend to be more
persistent,” says mammal palaeobiologist Christine Janis of Brown
University in Providence, Rhode Island. So on one hand natural
selection encourages animals to grow larger, but on the other it
eventually punishes them for doing so. This equilibrium between
opposing forces has prevented most land animals from exceeding about 10 tonnes.

Dinosaurs had skewed incentives and took on too much tail risk! If even evolution falls into this trap, God help the bank regulators…