Grey Swan: What It Is, How It Works, and Examples

What Is a Grey Swan?

The term grey swan refers to a potential event that can have a significant impact on the economy and financial world but is unlikely to occur. In other words, it is a risk with a potentially large impact but a low perceived likelihood of happening even though it isn't entirely impossible. Grey swans are commonly characterized as sudden shocks that may be predicted in the market. Because there is a slight chance the event will occur it should be anticipated, particularly as it could shake up the world economy and stock market.

Understanding Grey Swans

As noted above, grey swans are events that may have a significant impact on the markets. These events are not viewed as entirely improbable. This means that the possibility of their occurrence is known beforehand. They can be positive or negative and significantly alter the way the world operates, which is why we are urged to take them seriously.

Examples include natural disasters, such as Katrina, Britain’s unexpected decision to leave the European Union (EU), otherwise known as Brexit, Donald Trump winning the 2016 U.S. presidential election, or a revolutionary technological breakthrough, such as the internet.

The outcome of these types of events cannot necessarily be predicted with ease. However, that does not mean that those who stand to be affected should not draw up some form of a plan for how to potentially handle them, regardless of how improbable they might seem.

Evolution of the Grey Swan

Grey swan is a by-product of the black swan, a term popularized by finance professor, writer, and former Wall Street trader Nassim Nicholas Taleb. In his book, The Black Swan: The Impact of the Highly Improbable, Taleb describes a black swan as an entirely unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences. 

He outlined the three core attributes of a black swan as:

1. An outlier because nothing in the past can convincingly point to its possibility.
2. Carrying an extreme impact.
3. Something that can be rationally explained after it occurs.

Taleb’s theory became a fashionable way to classify all catastrophes. Then some observers began to note that not all big things that happen are out of the blue and completely improbable. Instead, some events are clearer and slightly easier to see coming, and not just in hindsight.

From there, the terms grey and white swan were born. The former is used to describe events that are more predictable than black swans, while the latter is characterized as something almost certain to happen.

Black, grey, and white swans also vary in terms of the impact they are perceived to have. White swans are said to have little implications, impacting the life of one or a group of people rather than the entire globe. Grey swans, and even more so black swans, are viewed differently, causing events that can be potentially devastating for many. The main difference between the two is that one is known about beforehand, while the other takes us completely by surprise.

The risk management implications of gray swans are different, too. Gray swans can be managed by building what Taleb refers to as resilience, or robust capabilities. Financial buffers, surplus production and supply chain capacity, built-in redundancies, and real options can help to withstand the impact of gray swans. Dealing with black swans goes beyond just building resilience, but becoming antifragile.

Examples of Grey Swans

Everything from climate change, population growth, and rising debt have been categorized as grey swans. We are aware of their presence, but perhaps do not take them seriously enough, even if each of them could end up having severe, wide-ranging consequences, such as triggering an earthquake or another Great Depression.

The COVID-19 pandemic is an example of a gray swan. Pandemics are a rare but well-acknowledged risk that the world has experienced repeatedly in the past, from the Justinian plague to the Black Death and the Spanish flu. Though the risk of a pandemic in any given year is estimated to be quite low based on past frequency, they can have dramatic and transformative effects on the economy and society.

The Bottom Line

Making predictions about where the economy is headed and the impact of certain events can be tricky. Grey swans are events that have the potential for significant impacts but may not necessarily occur. Though they may not happen, grey swans should not be ignored. Rather, there should be plans in place to combat them in case they do take place.