Tail risk
Tail risk, sometimes called "fat tail risk," is the financial risk of an asset or portfolio of assets moving more than 3 standard deviations from its current price, above the risk of a normal distribution.[1] Prudent asset managers are typically cautious with the tail involving losses which could damage or ruin portfolios, and not the beneficial tail of outsized gains.[2]
The common technique of theorizing a normal distribution of price changes underestimates tail risk when market data exhibit fat tails.
Tail risk is sometimes defined less strictly: as merely the risk (or probability) of rare events.[3] The arbitrary definition of the tail region as beyond 3 standard deviations may also be broadened, such as the SKEW index which uses the larger tail region starting at 2 standard deviations.
See also
- Black swan theory
- Global catastrophic risk
- Kolmogorov's zero–one law which is also known as a Tail event.
- Risk measure
- Tail risk parity
- Taleb distribution
- Value at risk
References
- "Tail Risk Definition". Investopedia. Retrieved February 6, 2011.
- Vineer Bhansali (December 2008). "Tail Risk Management: Why Investors Should Be Chasing Their Tails". PIMCO. Retrieved 30 March 2017.
- Ken Akoundi; John Haugh. "Tail Risk Hedging: A Roadmap for Asset Owners" (pdf). Deutsche Bank. Retrieved June 16, 2012.