Crash of 2008/Tutorials
Risk-management errors
- (for definitions of the terms shown in italics on this page see the glossary on the Related Articles subpage [[1]]
Tail risk
An explanation for risk-management errors that has been put forward by Andrew Haldane (Head of the Bank of England's Systemic Risk Assessment Department) [1] suggests that they arose from investors' and rating agencies' use of linear models based upon the CAPM (Capital Asset Pricing Model) [2]. Such models assume that risks can be represented by the symmetrical bell-shaped normal distribution, and can give inaccurate results if the true distribution has a "fat tail", as a result of which there is a significant additional tail risk. Earlier work by Raghuram Rajan (Director of Research at the International Monetary Fund) securitised assets may be expected to involve significant tail risks. [3] . Since the events involving such risks are by definition rare, they cannot be expected to be picked up by models based upon a five or six years' run of data.