Why Heavy Tails?

Abstract:     
Why does the distribution of returns on equity securities have fat tails? Why do the normative models generate empirical contradictions? Using both Bayesian and Frequentist methodologies, it is shown that the models of mean-variance finance do not follow from first principles and are not valid scientific models. This paper proposes first principles mechanisms to reconcile observations and economic principles and empirically tests the proposed alternative model.

Number of Pages in PDF File: 43

Keywords: Capital Asset Pricing Model, Arbitrage Pricing Theory, Black-Scholes Option Pricing Model, Capital, Inventory, Greater than Unit Root Processes, Cauchy Distribution

JEL Classification: B41, D80, D81, D84, E22, E44, G10, G11, G12, G14

working papers series