Distributional Characteristics
A normal distribution has three main characteristics: its mean and median are equal; it is completely defined by two parameters, mean and variance; and it is symmetric around its mean with:
- 68 percent of the observations within ±1σ of the mean,
- 95 percent of the observations within ±2σ of the mean, and
- 99 percent of the observations within ±3σ of the mean.
Skewness
Skewness refers to asymmetry of the return distribution, that is, returns are not symmetric around the mean. A distribution is said to be left skewed or negatively skewed if most of the distribution is concentrated to the right, and right skewed or positively skewed if most is concentrated to the left.
Kurtosis
Kurtosis refers to fat tails or higher than normal probabilities for extreme returns and has the effect of increasing an asset’s risk that is not captured in a mean–variance framework.
Market Characteristics
Although informational efficiency of markets is a topic beyond the purview of this reading, we should highlight certain operational limitations of the market that affect the choice of investments. One such limitation is liquidity.
