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Friday, 27 June 2008
The Fat Tail bit me - again.
January '08 was a terrible month for my net worth - declining 7.78% from 25 Dec - 24 Jan. If one assumes a normal distribution of monthly returns, the figures since May 2002 would indicate this has an estimated frequency of just 0.09% IE. I'd expect such a bad month to occur once every ninety years or so. However, my June monthly measurement (from 27 May - 26 Jun) just produced a second abysmal monthly result within six months, down 7.10%, which has an expected frequency of around 0.16%, or roughly once every fifty years. As can be seen from the plot of actual monthly returns vs. the fitted normal distribution, my monthly returns don't follow a classic normal distribution - with a large percentage of my portfolio invested in growth assets it suffers from the "Fat tail" effect, whereby "outlier" events occur more frequently than would be expected for a normally distributed, random variation. Once possible explanation of such results is behavioural economics, or the "madness of crowds". Given the relatively robust state of the Australian economy, excessive fear seems to have afflicted the local stock market. If I wasn't already fully invested (and geared!) into stocks I'd be looking at investing in stocks at this time. As it is, all I can do is hold on, and hope this is close to the bottom of this particular roller-coaster dip.