FAT TAILS.

FAT TAILS. Kids, you have encountered bell-shaped curves in tests that are graded “on the curve.” That “curve” is a “normal probability distribution”, which has a bell shape. This wikipedia article has right at the beginning four curves of probability distributions with the red one being the normal distribution. Normal distributions are used a lot in statistics. Taleb argues that normal distributions have been used too much in financial modeling because they are convenient to work with. Think of the curves as showing the probability of results that extreme, that are large deviations from the average. Taleb thinks large deviations in the financial world occur frequently. That is, the probability distributions in the financial world look like the flat curve in the wikipedia article (the one with the gray dots). These are referred to as fat tail distributions because large deviations have a greater probability of occurring.