This will be a real challenge but it should be an interestin

This will be a real challenge, but it should be an interesting challenge. Much of the way we measure risk relies on probability distribution (the bell curve as shown on page 425). For many things in life, and business, this is perfectly valid, but for others it is not. Can you come up with some illustrations of business risk measurement where bell curve type analysis is inappropriate? This will take a little research on the Internet. Why may the bell curve be an inappropriate tool for looking at market risk? Find out what Mandelbrot (The Mis Behvior of Markets) and Taleb (The Black Swan) have to say.

Solution

you can\'t do a bell-curve analysis when the data doesn\'t follow a bell curve (normal distribution).

One common example is stock prices. They exhibit what some call \"fat tails\": large percentage moves are much more common than a normal distribution would predict.

One type of illustration that comes to mind is in stock prices and the market. The Bell Curveformat would be inappropriate for this type of measure of risk because it does not exhibit or relyon probability distribution. By this I mean in stock prices we can deal with large moves ofpercentages which are harder for normal distribution to predict, thus making it hard to use thebell curve in this type of analysis and is a inappropriate tool for market risk due to the large “fat tails” produced. Mr. Mandelbrot sees markets as math based, and his book explains how markets behave like his fractal theory. This produces both unique insights and a handful of misconceptions but is ultimately a worthy addition to financial theory. Where as Mr. Taleb thinks that the markets are actually riskier than most believe, and that the so-called \"fat tail\" or \"Black Swan\" events are much more frequent than current financial theory can account for. Where the two men differ on their opinions is Taleb believes in pure stochasticity (random chance), and even views stocks\' long-term returns as \"random drift.\" Mandelbrot does not: He is a firm believer in patterns and that fundamentals ultimately rule stock returns and the power of probability in forecasting future prices