The Impact of Skewness and Fat Tails on the Asset Allocation Decision

Abstract

The authors modeled the non-normal returns of multiple asset classes by using a multivariate truncated Lévy flight distribution and incorporating non-normal returns into the mean-conditional value at risk (M-CVaR) optimization framework. In a series of controlled optimizations, they found that both skewness and kurtosis affect the M-CVaR optimization and lead to substantially different allocations than do the traditional mean–variance optimizations. They also found that the M-CVaR optimization would have been beneficial during the 2008 financial crisis.

Keywords: Portfolio Management: Asset Allocation, Quantitative Methods, Basic Statistical and Probability Concepts, Measures of Kurtosis, Measures of Skewness