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Tail Risk

Tail risk refers to the risk of extreme price movements or rare events that lie in the tails of a probability distribution, far from the average or expected outcome. These events, though rare, can have catastrophic consequences, such as financial crises or market crashes. Tail risks are difficult to predict and can significantly impact portfolios, especially during periods of high volatility or systemic stress.

Example

The 2008 financial crisis is considered a tail risk event because it was an extreme, unexpected event that severely impacted global financial markets.

Key points

• The risk of extreme, rare events that occur in the "tails" of a probability distribution.

• Such events can lead to significant financial losses.

• Often associated with market crashes or systemic failures.

Quick Answers to Curious Questions

Tail risks are rare but can lead to large, unexpected losses that are not typically accounted for in standard risk models.

Investors can use tail risk hedging strategies, such as buying options, volatility products, or portfolio diversification across uncorrelated assets.

Tail risk refers to extreme, rare events that fall outside normal expectations, while standard market risk refers to more predictable price movements within the typical range.