Fat Tail Events – Does My Tail Look Fat In This? [Part 1]

Investors and managers are concerned with "fat tails". In part one of a two part article we look at where fat tails come from and how they can be managed.

Introduction

“Extreme events”, “nonlinear dynamics”, “power laws”, “flash crashes”, “fractal processes”… a lot of academic, journalistic and practitioner ink has been spilled about “fat tail events” in financial markets. As is so often the case, a great deal of confusion has been generated by the casual use of subtle statistical concepts. Although this article isn’t attempting to be a statistical primer, it might help to illustrate and illuminate some of these subtleties and to manage the risk of fat tail events.

The existence of fat tails in the financial markets results from the...