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Thrasymachus comments on Why the tails come apart - Less Wrong

116 Post author: Thrasymachus 01 August 2014 10:41PM

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Comment author: Thrasymachus 02 August 2014 02:15:08AM 4 points [-]

Interesting: Is there a story as to why that is the case? One guess that springs to mind is that market performance in sectors is always correlated, but you don't see it in well functioning markets due to range restriction/tails-come-apart reasons, but you do see it when things go badly wrong as it reveals more of the range.

Comment author: Cyan 02 August 2014 11:39:15AM *  3 points [-]

market performance in sectors is always correlated, but you don't see it

The problem is the word "always". If I interpret it to mean "over all possible time scales" then the claim is basically false; if I interpret it to mean "over the longest time scales" then the claim is true, but trivially so given that sector performances are sometimes correlated.

We won't get to an explanation by just thinking about probability measures on stochastic processes. What's needed here is a causal graph. The basic causal graph has the financial sector internally highly connected, with the vast majority of the connections between lenders/investors and debtors/investees passing through it. That, I think, is sufficient to explain the stylized fact in the grandparent (although of course financial researchers can and do find more to say).