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What is Tail Risk?

The common technical definition of tail risk is the risk of an investment moving more than three standard deviations from the mean is greater than what is shown by a normal distribution. Using normal statistical methods often underestimates this risk. So what does this mean in plain English and how does it relate to your portfolio? When a portfolio is typically constructed, it is assumed its returns will fall with an expected range – either positive or negative 99.97% of the time. However, the concept of tail risk suggests that this distribution of returns is not normal and is actually skewed. Therefore, the returns don’t always fall within the expected range, meaning it has fatter tails. The fatter tails increase the likelihood that the investment will move beyond the outer range. Since the last decade has reminded us that improbable events can and do happen, at High Country Capital Management we construct portfolios with this risk in mind and attempt to reduce it by incorporating multiple asset classes and investment strategies in portfolios.


Recent examples of left-tail events

    YearsCrisis
    2011European debt crisis; Japan earthquake and tsunami
    2007-2009Subprime/credit/global financial crises
    2001-2002Dot-com bust; September 11 attacks; Argentine debt default
    1998Long-Term Capital Management Fund collapse; Russian debt default
    1997-1998Asian financial crisis
    1994-1995Mexican peso crisis
    1992-1993European monetary system crisis
    1989-1991U.S. savings and loan collapse; Latin American debt crises
    1987Black Monday &$40;U.S. stock collapse)
    1982Mexican debt default; international debt crisis

Source; PIMCO