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Correlations have fat tails, too
April 2011
You are probably familiar with the idea of fat tails—extreme outcomes can occur more frequently (i.e., tails are fatter) in practice than implied by a normal distribution. However, many investors haven't realized that volatility does not fully illustrate the uncertainty associated with asset returns—correlations have fat tails, too. This paper outlines why traditional modeling falls short and how investors may be relying too heavily on correlation statistics when making decisions about liability hedging and diversification.
This article was first published in Investments & Wealth Monitor, March/April 2011.
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Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.
Russell Investment Group is a Washington, USA corporation, which operates through subsidiaries worldwide, including Russell Investments, and is a subsidiary of The Northwestern Mutual Life Insurance Company.
Date of first use: April 2011
USI-9503
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