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

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

Source; PIMCO