Measuring Investment Risk Based on Tail Thickness

In recent years, both institutional and individual investors have come to rely heavily upon techniques for analyzing (defining and measuring) risk. In this respect, the issue that continues to require the attention of academic researchers and practitioners alike is how to concisely define investment risk and, more importantly, how to best measure it. Selecting an appropriate risk definition involves trade-offs among ease of measurement, forecast ability, and intuition of individual investors. The purpose of this paper is to present an alternative index for measuring unconditional (or total) risk. The proposed measure reflects behavior in general, and thickness in particular, of the lower tail of the distribution of returns. We therefore argue it provides a more useful and reasonable index because, unlike measures frequently used, its estimation depends upon the most relevant data from the sample distribution. We describe risk analysis based on lower tail behavior and identify its advantages over existing methods. Finally, using data of weekly returns to the CREF Stock Fund, we provide an empirical example to illustrate the technique. Copyright 2001 by Kluwer Academic Publishers