Tail Risk

AAA

DEFINITION of 'Tail Risk'

A form of portfolio risk that arises when the possibility that an investment will move more than three standard deviations from the mean is greater than what is shown by a normal distribution.

INVESTOPEDIA EXPLAINS 'Tail Risk'

When a portfolio of investments is put together, it is assumed that the distribution of returns will follow a normal pattern. Under this assumption, the probability that returns will move between the mean and three standard deviations, either positive or negative, is 99.97%. This means that the probability of returns moving more than three standard deviations beyond the mean is 0.03%, or virtually nil. However, the concept of tail risk suggests that the distribution is not normal, but skewed, and has fatter tails. The fatter tails increase the probability that an investment will move beyond three standard deviations.

Distributions that are characterized by fat tails are often seen when looking at hedge fund returns.

RELATED TERMS
  1. Leptokurtic

    A statistical distribution where the points along the X-axis ...
  2. Platykurtic

    A type of statistical distribution where the points along the ...
  3. Long Tail

    In business, long tail is a phrase coined by Chris Anderson, ...
  4. Hedge Fund

    An aggressively managed portfolio of investments that uses advanced ...
  5. Covariance

    A measure of the degree to which returns on two risky assets ...
  6. Risk

    The chance that an investment's actual return will be different ...
Related Articles
  1. Investing Basics

    Determining Risk And The Risk Pyramid

    Many investors do not understand how to determine the risk level their individual portfolios should bear.
  2. Mutual Funds & ETFs

    Understanding Volatility Measurements

    How do you choose a fund with an optimal risk-reward combination? We teach you about standard deviation, beta and more!
  3. Fundamental Analysis

    The Capital Asset Pricing Model: An Overview

    CAPM helps you determine what return you deserve for putting your money at risk.
  4. Economics

    What's the relationship between r squared and beta?

    Learn about the relationship between R-squared and Beta. Explore how the concepts are related and often used in conjunction with portfolio Alpha.
  5. Mutual Funds & ETFs

    How do hedge funds use short selling?

    Learn how hedge funds use short selling to profit from stocks that are falling in price. Explore different analytical techniques hedge funds employ to find investments.
  6. Economics

    What are some limitations of the consumer price index (CPI)?

    Explore some of the basic limitations of the widely used economic indicator, the consumer price index, or CPI, and examine the criticism of its accuracy.
  7. Economics

    Is the consumer price index (CPI) a cost of living index?

    Explore the consumer price index (CPI) and understand why it is not an actual cost of living index although it is often identified as one.
  8. Economics

    Where do funds report their r-squared?

    Learn where to find R-squared calculations for mutual funds. Explore R-squared, Alpha and Beta and how these calculations measure securities' performance.
  9. Fundamental Analysis

    How do you calculate r-squared in Excel?

    Calculate R-squared in Microsoft Excel by creating two data ranges to correlate. Use the Correlate formula to correlate both sets of data, or x and y.
  10. Fundamental Analysis

    What are the most common issues with Serial Correlation in stocks?

    Read about the concept of serial correlation in stock returns, and learn why market analysts are divided about the efficacy of trading based on stock patterns.

You May Also Like

Hot Definitions
  1. Prospectus

    A formal legal document, which is required by and filed with the Securities and Exchange Commission, that provides details ...
  2. Treasury Bond - T-Bond

    A marketable, fixed-interest U.S. government debt security with a maturity of more than 10 years. Treasury bonds make interest ...
  3. Weight Of Ice, Snow Or Sleet Insurance

    Financial protection against damage caused to property by winter weather specifically, damage caused if a roof caves in because ...
  4. Weather Insurance

    A type of protection against a financial loss that may be incurred because of rain, snow, storms, wind, fog, undesirable ...
  5. Portfolio Turnover

    A measure of how frequently assets within a fund are bought and sold by the managers. Portfolio turnover is calculated by ...
  6. Commercial Paper

    An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories ...
Trading Center