Background:
Skill in the game implies that one cannot take risks that may harm others without being personally affected. Hammurabi’s Code exemplifies this concept by punishing architects if their buildings collapse and cause harm.

Deterrence and Risk Management:
The rule in Hammurabi’s Code aimed to deter architects from cutting corners in construction by risking the lives of homeowners. The idea of personal harm as a deterrent is powerful and has been influential in shaping moral philosophy, ethics, and civil society.

From Negative to Positive Rules:
Moral philosophy evolved from negative rules (e.g., “don’t do to others what you don’t want done to you”) to positive rules (e.g., “do to others what you want done to you”).

The Silver and Golden Rules:
Hillel’s silver rule emphasizes avoiding harm to others, while the golden rule encourages positive actions towards others. Isocratis applied the golden rule to states, suggesting that stronger states should treat weaker states fairly, just as they would want to be treated.

Kant’s Categorical Imperative:
Kant’s categorical imperative is a modern culmination of these moral principles, emphasizing acting in accordance with maxims that can be universalized.

The Impartial Spectator:
Adam Smith’s concept of the impartial spectator suggests that we consider our behavior as if someone were watching us, influencing our moral decision-making.

Opacity and Information Asymmetry:
The incentives for the builder in Hammurabi’s Code illustrate the dangers of opacity (non-transparency) and information asymmetry. These concepts are crucial in understanding risk management and the foundation of the paper presented.

Asymmetric Probability Distributions:
Tail events, particularly in asymmetric probability distributions, exhibit a unique property: the mean is not easily observed due to the preponderance of small gains and large losses.

80-20 Rule Example:
The 80-20 rule illustrates this concept: 20% of the companies generate 80% of the profits, and vice versa.

Anti-fragile Ethical Rule:
An anti-fragile ethical rule prevents the exploitation of one party’s anti-fragility at the expense of another, such as someone holding an option against someone else.

Misunderstood Law of Large Numbers:
The law of large numbers is often misunderstood, leading to the assumption that observing a series of data points reveals the true mean.

Fat Tails and Extreme Values:
In fat-tailed distributions, the maximum value observed over time tends to converge towards the total mean, implying that a single extreme event can dominate the entire series.

Nickels in Front of a Bulldozer:
The analogy of picking up nickels in front of a bulldozer highlights the danger of focusing on small, steady gains while ignoring the potential for catastrophic losses.

Irrelevance of Small Gains:
In a fat-tailed process, the small gains are irrelevant compared to the potential for a single large loss that can wipe out all previous profits.

Concealment of the Mean:
Ninety percent of observations in a fat-tailed process will be below the mean, meaning that the true mean remains hidden for most of the process’s duration.

Bonus Years and Reputation:
In such a process, a series of bonus years can create the illusion of success, leading to a reputation for brilliance until a single disastrous year wipes out all gains.

Success and Perception:
In modern society, successful individuals often gain fame and recognition, which can lead to a false sense of security.

The Problem with Reputation:
Reputation is easy to gain and can be misleading, allowing individuals to take excessive risks without facing consequences.

The Incentive to Maximize Gains and Minimize Losses:
When individuals do not bear the losses resulting from their actions, they are incentivized to pursue strategies with high potential gains but also significant potential losses.

The Importance of Personal Accountability:
Requiring individuals to have “skin in the game” ensures they bear the consequences of their decisions and encourages responsible behavior.

The Builder Analogy:
Holding builders accountable for house collapses, even in cases of bad luck, can lead to excessively expensive and safe houses.

Balancing Accountability and Risk:
There needs to be an equilibrium between accountability and risk, allowing for some level of risk-taking while still incentivizing responsible behavior.

The Asymmetry of Capitalism:
Capitalism allows for unlimited profits but limits losses through bankruptcy, creating an imbalance that can lead to excessive risk-taking.

The Need for Financial Penalties:
Financial penalties can be effective in incentivizing responsible behavior, without resorting to extreme measures like executing individuals.

Hyperinflation and Bureaucrats:
Bureaucrats causing hyperinflation and affecting savers and citizens without facing consequences is a significant concern.

The Value of Heuristically Discovered Equilibrium:
Contracts between individuals can often find an equilibrium that balances accountability and risk, but this is not always the case in modern society.

Skin in the Game as a Heuristic:
Skin in the game is a heuristic that aligns incentives and creates natural accountability in decision-making. It can be enforced between individuals engaging in a contract without state intervention. Examples include a cook tasting their own food and individuals standing to lose from their advice.

Skin in the Game as a Moral Concept:
It is immoral to make a forecast or recommendation without being subject to the consequences of its potential harm. This moral principle applies to various aspects of life, including financial advice, political decisions, and personal recommendations.

The Challenge of Government and Skin in the Game:
Governments, particularly centralized ones, often eliminate skin in the game by making decisions without direct accountability for their outcomes. Successful governments, such as those in Switzerland and Sweden, typically involve decision-makers embedded in communities, fostering alignment with local interests.

Skin in the Game in Political and Public Policy:
Governments should prioritize policies that promote skin in the game and avoid measures that undermine it. Decentralizing decision-making, fostering local engagement, and promoting individual responsibility can enhance skin in the game in public policy.

Conclusion:
Skin in the game is a crucial concept in economics, morality, and public policy. It ensures that decision-makers have a personal stake in the outcomes of their choices, leading to more responsible and ethical behavior.

Incentives in Government and Business:
Government officials often have less skin in the game compared to individuals in small communities, leading to a lack of accountability. In small communities, mistakes have immediate consequences, encouraging people to be more responsible. The law of large numbers works faster at the micro level, allowing for quicker identification of mistakes.

The Problem with Regulation:
Government interventions like bailouts and insurance policies can remove skin in the game, leading to moral hazards. Regulation often favors large entities over small ones, which can stifle innovation and competition.

The Solution:
Encourage localized systems where cause and effect can be easily identified, promoting accountability. Rely less on public policy and government regulation, letting systems evolve naturally. Implement skin-in-the-game rules to ensure that decision-makers have a personal stake in the outcomes of their actions.

Skin in the Game and Asymmetry:
The concept of “skin in the game” implies that individuals should bear the consequences of their actions. People with more upside than downside (positive asymmetry) benefit from random events and are considered “anti-fragile.” Conversely, those with more downside than upside (negative asymmetry) are fragile and dislike volatility, randomness, and stressors. This asymmetry is similar to a short-term option, where bankers benefit from volatility while society bears the burden of losses.

Moral Hazard with Fat Tails:
Moral hazard is not fully understood by economists when it comes to fat tails (extreme events). Fat tails are central to life and should be considered as such, rather than being dismissed as unquantifiable. The undetected asymmetry between compensation periods and the time it takes for variables to show their properties can lead to problems.

Optionality and Risk Transfer:
Some individuals, like taxpayers and investors, can be short optionality while others, like hedge fund managers, have more optionality and benefit from risks taken by others. Positive asymmetry involves voluntarily taking risks for the sake of others, altruistically benefiting society.

Honor, Prestige, and Risk-Taking:
Honor is often associated with courage and taking risks for the sake of others. Historically, prestige and rank were proportional to the risks taken for others. Heroes and lords were expected to protect others and take the first risks in battle.

Current Generation’s Lack of Risk-Taking:
In modern times, there seems to be a lack of risk-taking for the sake of others. Prominent figures like George W. Bush avoided military service, contrasting with previous generations of war heroes. The imbalance between those who make others take risks for them and those who take risks for others can lead to societal dysfunction.

Technology and Modernity:
Technology and modernity have disrupted the system, leading to a shift in culture and values. People now value their lives and health more than before, making them less willing to take risks. Bureaucrats have replaced risk-takers in positions of power.

Risk-Taking Entrepreneurship:
Risk-taking entrepreneurs take risks for the sake of others, even though the probability of success is low. They fail often, but collectively they are necessary for societal progress. Instead of glorifying these entrepreneurs, society often puts Harvard graduates on a pedestal.

Bureaucrats vs. Adventurers:
Bureaucrats benefit from the progress made by adventurers and risk-takers. England and America were built by adventurers, not bureaucrats. Society cannot evolve if it continues to favor bureaucrats over risk-takers.

Risk-Takers and the Importance of Respect:
Entrepreneurs like Amazon’s founders often face uncertainty and financial losses in their early stages. Investors who support these entrepreneurs deserve respect for bearing the risks while consumers reap the benefits. Restaurants in New York City exemplify the risks entrepreneurs take for the benefit of others. We should recognize and respect people who take risks in various domains, including the military, economics, and politics.

Simple Heuristics for Protection:
Ralph Nader’s heuristic for war suggests that individuals should only vote for war if they have a family member or descendant on the draft. This approach can help protect decision-makers from making reckless choices that could harm others.

Managing Money and Dealing with Losses:
As a money manager, Taleb experienced frequent losses, but he was comfortable with these setbacks. Clients would call to express concerns about losses, but Taleb’s significant financial exposure to the same portfolio minimized his guilt. Sharing the losses with clients eliminated guilt and conflicts.

The Rule of Thumb for Fund Diversification:
A common rule of thumb is for investors to allocate half of their net worth into a fund. This diversification strategy helps protect investors from significant losses.

Binary vs. Vanilla Events in Prediction:
Binary events are those with only two possible outcomes, such as “yes” or “no.” Vanilla events have more than two possible outcomes, such as the stock market going up, down, or sideways.

Understanding the Fat Tail Domain:
In real life, events have a third dimension: the depth of the event. Forecasting accuracy is not as important as the cumulative effect of predictions. The probability of an event is less significant than the potential payoff in fat-tailed domains.

Vanilla vs. Exotic Options:
Vanilla variables are natural variables with open-ended exposure. Exotic options are binary options with limited payoff.

The Problem with Prediction Markets:
Prediction markets are binary, while exposure is open-ended. A perfect track record in prediction markets is meaningless if the payoff is small.

Forecasting Events:
Forecasting should not be limited to binary outcomes. It should consider the different sizes of potential events and their respective probabilities.

Fat-Tailed Distributions:
Economic variables often have fat-tailed distributions, meaning the probability of an event is less important than the magnitude of the event. Small probabilities can be associated with large events, making predictions difficult.

Skin in the Game:
Skin in the game means having a stake in the outcome of a prediction. When someone has skin in the game, they are more likely to make accurate predictions. Without skin in the game, people may gain a reputation for making accurate predictions even if their predictions are actually inaccurate.

Binary Predictions:
Binary predictions are yes/no or true/false predictions. Binary predictions can be problematic when dealing with fat-tailed distributions because the probability of an event may be very low, but the magnitude of the event may be very high.

Ice Cream Cone vs. Slap on the Wrist:
If the consequences of making an incorrect prediction are minor, people may be more likely to make risky predictions. This can lead to a situation where people are rewarded for making risky predictions, even if those predictions are often inaccurate.

Black Swans:
Black swans are rare, unpredictable events that have a significant impact. The probability of a black swan event is very low, but the magnitude of the event can be very high. People often misinterpret black swans, believing that they are more likely to occur than they actually are.

Black Swans:
Nassim Taleb clarifies that black swan events are less frequent but have a deeper impact. A crazy individual with a nuclear bomb poses a greater danger than a person with a pistol. The problem lies in the lack of data to determine the probability of such events.

Binary Events and Risk:
People tend to overpay for lottery tickets and insurance, indicating a long-shot bias. This bias is limited to bounded payoff variables and doesn’t extend to open-ended payoffs. Financial options, with their potential for significant payoffs, are a prime example. The overpayment for lottery tickets does not translate to overpaying for financial options.

The Cost of Misjudging Payoffs:
Banks engaging in the business of selling small probabilities in finance suffered heavy losses in 2008, amounting to $5 trillion. Insurance companies have faced similar challenges, emphasizing the significance of data analysis and the disastrous consequences of misjudging payoffs.

Parenting and Skin in the Game:
Traditional parenting involves protecting children from harm in their early years. As they grow older, good parenting means letting children experience their own consequences and learn from their mistakes. This approach fosters anti-fragility and resilience.

Reforming Academia:
Academia needs a mechanism to address the immunity of economists to being wrong. The example of the Fed chair illustrates the problem of conflicting economic advice during crises.

Economists’ Bias and Skin in the Game:
Economists often have a bias towards spending government money, regardless of its purpose. On the other hand, some argue that we should not spend any government money at all. The inconclusive results of the $800 billion government spending during the financial crisis do not necessarily disprove the argument for spending more money. Economists should not have skin in the game, meaning they should not benefit personally from their economic advice. This bias can lead to economists making recommendations that are not in the best interests of society.

Building a System to Keep Economists’ Mistakes Local:
We need to build a system that prevents economists’ mistakes from having real-world consequences. This can be done by keeping economists in academia, where their mistakes will not directly affect the economy. The idea is to create an “ivory tower” for economists, where they can make mistakes without causing harm. This will allow economists to learn from their mistakes and improve their theories without jeopardizing the well-being of society.