The Origin of Fat Tails

Martin Gremm

Papers from arXiv.org

Abstract: We propose a random walk model of asset returns where the parameters depend on market stress. Stress is measured by, e.g., the value of an implied volatility index. We show that model parameters including standard deviations and correlations can be estimated robustly and that all distributions are approximately normal. Fat tails in observed distributions occur because time series sample different stress levels and therefore different normal distributions. This provides a quantitative description of the observed distribution including the fat tails. We discuss simple applications in risk management and portfolio construction.

Date: 2013-10, Revised 2014-05
New Economics Papers: this item is included in nep-ecm, nep-fmk and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations:

Published in International Journal of Theoretical and Applied Finance, Vol. 18, No. 8, 2015

Downloads: (external link)
http://arxiv.org/pdf/1310.4538 Latest version (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:1310.4538

Access Statistics for this paper

More papers in Papers from arXiv.org
Bibliographic data for series maintained by arXiv administrators ().