Fat Tail

What is a fat tail?

A fat tail is a probability distribution that more commonly forecasts movements of three or more standard deviations than a normal distribution. Periods of financial stress had resulted in market conditions with broader tails even before the financial crisis. Distributions with high kurtosis are also termed fat-tailed distributions.

Why are fat tails important in finance?

Periods of financial stress had resulted in market conditions with broader tails even before the financial crisis. This is significant because normal distributions understate asset prices, stock returns, and risk management measures.