Home of original “black swans” found to have smallest population of the statistical variety
Dec 18th, 2007 | Filed under: CAPM / Alpha TheoryStatisticians have a term for 20/20 hindsight. It’s “retrospective predictability” and it refers to the idea that previously unfathomable events often seem as if they were actually predictable once they occurred. In a sense, retrospective predictability is what makes stories of “famous last words” so compelling.
Statisticians also have their own take on the phrase “The only thing constant is change itself.” As author Nassim Nicholas Taleb (see related posting), mathematician Benoit Mandelbrot (see related posting) and others have shown change itself is actually inconsistent. In other words, volatility is volatile. And so you never really know the likelihood of extreme events.
Spanish academic Javier Estrada brings these two concepts together in this November 2007 article on what Taleb has called “black swan events” (in reference to the previously unfathomable discovery of black swans in Australia over 300 years ago).
Black swan events (the subject of Taleb’s best-selling book) cannot be explained by the commonly-made assumption that random events, such as stock market movements, followed the familiar bell curve (normal distribution).
Estrada applies this thinking to 15 equity markets around the world. He calculates the returns from the best and worst 10, 20, and 100 trading days. Then he calculates the returns a passive investor in those markets would have received if they had missed out on these small groups of trading days.
Estrada’s findings confirm the existence of black swans:
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Another attempt of the “Black Swan Movement” to present simple, well-known fact as a major discovery. After 50 years of research, we all know damn well that equity returns are not normally distributed (very few things are!) and that there are more extreme returns than one might expect. Isn’t that exactly one of the biggest challenges in equity investing?
[…] “Outliers” play an important role in equity market returns. (All About Alpha) […]
August 2007 proved that these crises seem to happen more and more often.