Finiteness of variance is irrelevant in the practice of quantitative finance
Identifieur interne : 000986 ( Main/Exploration ); précédent : 000985; suivant : 000987Finiteness of variance is irrelevant in the practice of quantitative finance
Auteurs : Nassim Nicholas Taleb [États-Unis]Source :
- Complexity [ 1076-2787 ] ; 2009-01.
English descriptors
Abstract
Outside the Platonic world of financial models, assuming the underlying distribution is a scalable “power law,” we are unable to find a consequential difference between finite and infinite variance models—a central distinction emphasized in the econophysics literature and the financial economics tradition. Although distributions with power law tail exponents α > 2 are held to be amenable to Gaussian tools, owing to their “finite variance,” we fail to understand the difference in the application with other power laws (1 < α < 2) held to belong to the Pareto‐Lévy‐Mandelbrot stable regime. The problem invalidates derivatives theory (dynamic hedging arguments) and portfolio construction based on mean‐variance. This article discusses methods to deal with the implications of the point in a real world setting. © 2008 Wiley Periodicals, Inc. Complexity, 2009
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DOI: 10.1002/cplx.20263
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