Brain Food Blog � Blog Archive � Mohamed A. El-Erian, President & CEO of Harvard endowment, on the global economy
Some thoughts from the guy who runs Harvard's endowment fund.
Proud Member Of
Random Roger
© 2009 | Gadget Theme Blogger Template
Original WPtheme By Blogger Template | Converted By Gadget Lover
| Distributed by eFree Blogger Help
Original WPtheme By Blogger Template | Converted By Gadget Lover
| Distributed by eFree Blogger Help
5 comments:
Please explain the "fat tail" comments in this set of notes on the speech given by Harvard's Edowments Fund top person. Especially the insurance aspects.
Thank you.
Interesting
Roger, I am also interested in understanding in more detail Mohamed A. El-Erian's comments:
Buy cheap insurance on fat tails
and
If world goes into recession, you want a liquid market. We think of recession as a risk under our ‘fat-tail’ insurance.
I thought the article was interesting.
Thx
Very interesting comments, indeed.
In all my years as an individual investor, managing my own portfolio, and seemingly in tune with relevent investment knowledge, I've never heard of the term "fat tail insurance". (Of course, I immediately found all sorts of info by Googling "what is fat tail insurance").
Now if I can just sift info to knowledge ...
The term "fat tail" refers to the distribution of returns over a given period of time. All modern financial theories rely upon a normal distribution for their calculations. What that essentially means is that 95% of the time the return figures should fall within plus or minus 2 standard deviations from the mean return. The fat tail he refers to is the fact that stock returns are NOT normally distributed and therefore the tails of the bell curve are actually fatter because more events happen out that far.
An example is Oct 19, 1987 when the market tanked. That was a 20+ standard deviation event. In a normal distribution we would not have "expected" that much of a drop even if we had been trading stocks every day since the big bang.
This is all some pretty complicated math and I could go on forever about the problems modern finance seems to ignore in search of asset pricing models (CAPM, APT, etc.)
"Fat Tail Insurance" I could only imagine involves buying very cheap insurance for outlier events that happen more frequently than models suggest they should.
If you are wildly interested in this topic (I am a nutbag quant and MBA student), I suggest you read three books:
Fooled by Randomness - Nassim Taleb
The Misbehavior of Markets - Benoit Mandlebrot
More than You Know - Michael Mauboussin
Each of them is an excellent read that will open your eyes to a world of problems surrounding modern financial modeling not the least of which is our reliance on the "normal distribution".
Post a Comment