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Tuesday, September 06, 2011

20 standard deviations event

The recent moves by the Swiss to control their currency resulted in a 20 standard deviation event.

 

http://blogs.reuters.com/felix-salmon/2011/09/06/charts-of-the-day-swiss-franc-edition/

 

“If you borrow in a low-yielding safe currency and invest in a higher-yielding risky currency, you make money every day, but can lose it all — and then some — with one violent currency move, when the risky currency suddenly weakens.

Today, however, it’s the other way around. With one announcement, the Swiss National Bank sent the Swiss franc — a classic safe currency, which rallies in times of uncertainty — plunging. “

And that’s how you get a 20 standard deviation event: you take something that is very, very steady from day to day and throw in an 8% change. In short, it results from believing the past data can be trusted into the future – the classic forecasting error.  An 8% move by itself isn’t horribly unusual for a currency, but is unusual for the Swiss franc.

This “20 standard deviations” event is what we might term a “black swan” – an event that has been assumed not to have any probability of occurrence.  But, whether possible or not, it did occur.

How many more black swans will we see in the current economic downturn?