What are black swans? You might be asking yourself this question. After all, you are reading a financial blog. What does a black swan have to do with Wall Street and financial trading? Well, if you looked at what happened during the great financial crash of 2008, you would realize that black swans have everything to do with the stock market.
Black swans in economics mean unexpected events that produce dramatic changes. Normally, these changes are quite negative. We are talking about the whole financial house of cards crashing down. The interesting thing about black swans is that they are not as unforeseen and sudden as previously imagined.
The biggest black swan event in recent memory is the crash of the trading house Lehman Brothers. On one hand, it was almost unimaginable that a bank the size of Lehman Brothers would go belly up. On the other hand, there were a lot of signs that the space that Lehman was playing in was in trouble. Lehman Brothers was taking a big bet on credit default swaps. It was betting that there wouldn’t be a high level of credit defaults. It was collecting this form of insurance for dirt cheap, and was hoping that there would be no major event that would trigger a huge wave of defaults.
Well, it appears that Lehman Brothers wasn’t really paying attention to the market. The market actually dipped previously due to concerns regarding subprime mortgages. Since subprime mortgages are related to credit defaults, it would be a stretch to say that Lehman Brothers didn’t see that coming. What people didn’t see coming, however, was Lehman Brothers going down.
This is crucial to determining what the next black swan event might be. First, we can already tell a limited set of events that might trigger the black swan. Second, the actual black swan event must be related to the trigger. With these clues, pinpointing a black swan event is not as big of an impossibility as most people think it is.