What are fat tails in financial markets?

What are fat tails in financial markets?

Fat tails refer to the phenomenon where extreme events occur more frequently than predicted by normal distribution. In finance, this means that the likelihood of extreme price movements is higher than what traditional models suggest.

Why are fat tails important for risk management?

Fat tails are crucial for risk management because they indicate that potential losses can be much larger than expected. This requires financial institutions to adopt more robust risk assessment strategies.

Can you give an example of a fat tail event?

Sure! The 2008 financial crisis is a classic example of a fat tail event, where the market experienced extreme volatility and losses that were not predicted by standard models.

How can investors protect themselves from fat tail risks?

Investors can protect themselves by diversifying their portfolios, using options for hedging, and employing risk management strategies that account for extreme events.