Tail Risk Measurement Heuristics

Nassim Nicholas Taleb develops two approaches to reasoning about extreme risk. In the first part, on the law of large numbers in the real world, he defines fat-tailed distributions and examines why conventional statistical procedures can perform poorly for economic variables. He stresses the much larger data requirements and the choice of estimators when rare observations dominate outcomes.

The second part considers how to detect fragility in portfolios. Taleb describes fragility as sensitivity to volatility and argues for analysing the shape of an exposure and its response to shocks when reliable numerical estimates of tail probabilities are unavailable. The lecture connects limitations of statistical estimation with practical heuristics for identifying vulnerability.