We Don't Quite Know What We are Talking About When We Talk About Volatility
Daniel G. Goldstein
Microsoft Research New York City; London Business School
Nassim Nicholas Taleb
NYU-Poly; Université Paris I Panthéon-Sorbonne - Centre d'Economie de la Sorbonne (CES)
March 28, 2007
Journal of Portfolio Management, Vol. 33, No. 4, 2007
Finance professionals, who are regularly exposed to notions of volatility, seem to confuse mean absolute deviation with standard deviation, causing an underestimation of 25% with theoretical Gaussian variables. In some fat tailed markets the underestimation can be up to 90%. The mental substitution of the two measures is consequential for decision making and the perception of market variability.
Number of Pages in PDF File: 8
Keywords: finance, volatility, risk, intuition, statistics, metrics
JEL Classification: D8, D9, E2, G2, N2Accepted Paper Series
Date posted: March 14, 2007 ; Last revised: November 16, 2012
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