Tail risk

Tail risk is the additional 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 tail risk involving losses which could damage or ruin portfolios, and not the beneficial tail risk 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

• Kolmogorov's zero–one law which is also known as a Tail event.
• Risk measure
• Taleb distribution
• Value at risk
• Black swan theory
• Tail risk parity

References