Fat Tails: The New Normal Empirical Tests For A Theoretical Model

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2014
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Haverford College. Department of Economics
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Thesis
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Award
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eng
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Open Access
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Abstract
Due to its "fat tails", the power law distribution provides an effective model of the tail of stock returns, volume and the distribution of the size of institutional investors, especially in comparison to the normal distribution. Gabaix et al. [2006] put forward a model where fatter tails in the distribution of institutional investors cause fatter tails in the distribution of stock returns and volume. Using data on stock returns, volume, and institutional investors, I apply Granger Causality to show that there is little empirical evidence for the relationship that their model puts forward. Next I discuss the problems with their model that lead to the lack of applicability of the model to empirical data. While these results detract from the legitimacy model, it does not diminish the effectiveness of the power law distribution in financial markets.
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