The truth about asymmetric market returns: fat-tails and black swans
Market returns are asymmetric, they have fat-tails that make market data an asymmetrical distribution, not a symmetical normal distribution. Extreme Events on a Univariate Level: Understanding the Fat-tails of a Risk Driver reveals:
These findings prove that risk estimates based on the normal distribution, even with volatility clustering, systematically misrepresent the true nature of the risk being taken. More sophisticated modelling techniques are necessary in order to capture widely observed phenomena such as risk asymmetry and fat tails.
Source: http://www.finanalytica.com/uploads/ExecutiveBriefings/Factor_Distribution_Case_Study_-_5-21-09.pdf
Comments (2)
Read through and enter the discussion by using the form at the endMark - January 22, 2012 10:40 PM
Asymmetric returns is very true. Investments tend to have return distributions skewed to the left (negative) or skewed to the right (positive). Co-skewness can play a role in reducing tail risk of a portfolio. A few years ago I wrote a paper on this subject "Skewing Your Diversification"
http://www.shorecapmgmt.com/skewing-your-diversification.html
Mike Shell - January 24, 2012 9:30 AM
Thanks Mark, I'll take a look.