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Going to Extremes: Leptokurtosis as an Epistemic Threat

In: Postmodern Portfolio Theory

Author

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  • James Ming Chen

    (Michigan State University)

Abstract

“Time present and time past/are both present in time future/and time future contained in time past.”1 In projecting forward rather than backward over time, economic forecasting cannot escape “timeless” moments of a different sort: the mathematical moments of the distribution of financial returns.2 Of the four moments of greatest interest to financial institutions and their regulators3—mean, variance, skewness, and kurtosis—it is the fourth moment, kurtosis, that should pose the deepest epistemic concern. Kurtosis eludes detection where it counts most—in its fat tails. Our expectations and perceptions may underestimate the most extreme risks by a significant margin. The overarching goal in financial responses to leptokurtosis and “fat tails” is the accurate forecasting of extreme events. Simple accuracy in description, if attainable and attained, would be a fantastic accomplishment.

Suggested Citation

  • James Ming Chen, 2016. "Going to Extremes: Leptokurtosis as an Epistemic Threat," Quantitative Perspectives on Behavioral Economics and Finance, in: Postmodern Portfolio Theory, chapter 0, pages 237-245, Palgrave Macmillan.
    • Handle: RePEc:pal:qpochp:978-1-137-54464-3_12
    DOI: 10.1057/978-1-137-54464-3_12
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