PRICING FAT TAIL RISK.

PRICING FAT TAIL RISK. Kids, you will note that the “fat tail risks” that are currently being recognized by the crude oil markets—possible trouble in Russia or the Middle East, collapse of the eurozone— are also fat tail risks in the financial markets generally. We live in a fat tail world. Taleb says that we always did, that the markets simply didn’t recognize that we did. I posted here about how one of my first posts on this blog (some five years ago) reported that Professor Larry Summers was saying (before the beginning of the financial crisis) that “financial markets are pricing in an expectation of tranquillity as far as the eye can see.” They were not pricing in the fat tail risk that was there. Nassim Nicholas Taleb and Mark Blyth wrote in an article in Foreign Affairs this summer that: “Seeking to restrict variability seems to be good policy (who does not prefer stability to chaos?), so it is with very good intentions that policymakers unwittingly increase the risk of major blowups.” The title of the article was “THE BLACK SWAN OF CAIRO: How Suppressing Volatility Makes the World less Predictable and More Dangerous”. It is a good thing that, at least for a time, the markets are reflecting some of the fat tail risks that we face.