Like the risk models that failed then, the standard deviation in a Sharpe ratio would use historic data on volatility and assume a normal distribution for market moves. So-called black swan events (rare and unexpected), like America’s first ever steep decline in house prices, can and will occur.

Black swans are, of course, those highly improbable but painfully consequential events that strike from the blue — or from the streets of Cairo, or from an offshore oil rig, or from a poorly designed car part. They can destroy a company's reputation, cripple its financial performance, and perhaps even kill it outright. Because they are rare and almost impossible to predict, black-swan events tend to fall outside the scope of most companies' risk-management programs (assuming a company has such a program at all).

Solon also had the intuition of a problem that has obsessed science for the past three centuries. It is called the problem of induction. I call it in this book the black swan or the rare event.