The Times Magazine discusses the debate over Value at Risk, or VaR, a popular across-the-board measure of risk on Wall Street, and the area in which I currently work. I haven't read "The Black Swan", but Taleb certainly comes across as kind of an ass in the article. It's perfectly plausible to say that "improbable" adverse events are a lot more frequent than most people realize. It's another thing to claim that VaR is useless, or that risk managers are being foolish.

The article mentions that Taleb has his own hedge fund, the ominously named Black Swan Protection Protocol, and has made "a killing" in each of the last three crises, achieving returns of 65% to 115%. But how much has he made in between? One assumes that he either goes short the market, or buys safe assets like treasuries, or some mix (I think there would have to be some of the former, or significant leverage, to achieve those returns). The S&P 500 is currently up about 260% since 1987, when he made his first killing.

There are a lot of perma-bull analysts, and fewer perma-bears. The historical returns of the market explain the population gap. And when there is a crisis, the perma-bears are trotted out on CNBC and the bookshelves as Cassandras, because they take the generally less popular viewpoint. But it's truly rare to find someone who was a bull at the right time and a bear at the right time, even for one of each cycle.

So Taleb doesn't seem to be improving on any current models simply by being bearish. As the article says, assuming that a disaster is always right around the corner would prevent you from making any investment. Obviously many risk managers made fatal mistakes in the current crisis, and there are plenty of places to assign blame. But it may well be that the optimal strategy is to assume that tomorrow will be more or less like today, even if you know that sometimes you will be wrong.

Update: my colleague Victor tells me that Taleb's strategy is most likely implemented using long-dated, deep out-of-the-money put options. Or in layman's terms, insurance policies that his theories indicate are cheaply priced (due to the chronic tendency to underestimate the likelihood of crises), and which pay off handsomely when crises occur. Until that happens, he would lose money little by little.

This pattern of returns probably takes a strong investing temperament, but it does seem compelling, and might catch on as a way to allocate some of one's money. Of course if it does, the supposed mispricings that he is advantage of could disappear.