Kurtosis is a statistical measure that describes the shape of a distribution's tails in relation to a normal distribution. In finance, kurtosis is used to assess the risk of investments, particularly the likelihood of extreme returns. A high kurtosis indicates that an investment is more likely to experience extreme values, both high and low, compared to a normal distribution.
For investors, understanding the kurtosis of an asset's return distribution is crucial for risk management. Investments with high kurtosis are considered riskier, as they have a higher probability of extreme gains or losses. This is particularly important for tail risk management, which focuses on guarding against significant losses that occur infrequently but have severe impacts.
When using kurtosis in portfolio management, it's important to recognise its limitations. Kurtosis alone does not provide a complete picture of risk, as it does not differentiate between positive and negative extreme values. It should be used in conjunction with other statistical measures like volatility and skewness, and in the context of broader investment analysis, to make informed decisions about risk and diversification in a portfolio.
This Trustnet Learn article was written with assistance from artificial intelligence (AI). For more information, please visit our AI Statement.