Thursday, September 29, 2011

Red Sox, Black Swans, and Sure Things

Red Sox Nation is in mourning today.

Last night, the Red Sox just completed one of the worst - if not the worst - collapses in modern baseball history.

The Tampa Bays Rays - whose payroll is a fraction of the Red Sox, by the way - captured the wild card berth that only a month ago seemed as remote as snow in July.

The New York Times carried an interesting article this morning which put in statistical terms just how unlikely it was that Tampa Bay, and not Boston, would be the playoffs starting tomorrow.

Using data from a statistical sports service called, here's how implausible last night's outcome was:

The following is not mathematically rigorous, since the events of yesterday evening were contingent upon one another in various ways. But just for fun, let’s put all of them together in sequence:
  • The Red Sox had just a 0.3 percent chance of failing to make the playoffs on Sept. 3.
  • The Rays had just a 0.3 percent chance of coming back after trailing 7-0 with two innings to play.
  • The Red Sox had only about a 2 percent chance of losing their game against Baltimore, when the Orioles were down to their last strike.
  • The Rays had about a 2 percent chance of winning in the bottom of the 9th, with Johnson also down to his last strike.
  • Multiply those four probabilities together, and you get a combined probability of about one chance in 278 million of all these events coming together in quite this way.

    And yet there it is: the Red Sox are out.

    My point of mentioning all of this today is not to belabor the obvious pain that Sox fans feel, but more to point out that in investing, just like in sports, "sure things" often turn out wrong.

    At the beginning of this year, for example, interest rates were poised to rise, or so most economists believed. By early February 2011, the 10 year Treasury stood at 3.75%, and the sages nodded their collective heads with the wisdom that the bond vigilantes were administering a 2x4 to the US government and its profligate ways.

    So now, with the 10-year Treasury now yielding 2%, it would appear that interest rates have fallen against all odds.

    Economists like to call improbable events "black swans" after the economist Karl Popper. Popper's insight was that finding all available swans are colored white does not mean that there aren't any swans colored black. Instead, it just means that black swans are less likely than white.

    It is the unlikely events - black swan events, if you will - that create the most havoc in the world. By considering the possibility of an event that seems unlikely - a Red Sox collapse, or lower interest rates - opportunities can arise.

    Just ask Tampa Bay this morning.