Discussion Post – Coursework Example
Business Risk Measurement-Bell Curve The Bell curve, otherwise known as the Gaussian bell curve is a statistical tool used to analyze different situations in life. In finance, the Bell curve is used mainly to analyze and predict business risks that might present in the future. As the name suggests, a Bell curve is a statistical tool that assumes that events follow the normal distribution (Garlick 44). Nevertheless, evidence shows that many events in life do not follow a normal distribution. Stock prices are a classical example of a business risk measurement where Bell curve cannot be appropriately applied. As earlier stated, Bell curve is only appropriate for use in analyzing business situations that follow the normal distribution. Unfortunately, evidence shows that stock prices do not follow a normal distribution pattern. This is because, if the stock prices were to be normally distributed as some people might suggest, then we would expect to experience the recent debt crash of 2007/2008 after a century or less. Contrarily, the world is faced by debt crash almost after every ten years or less. Accordingly, the crash we often see quite often is a clear indication that stock prices are not normally distributed. As such, Bell curve cannot be an appropriate analytical tool for measuring risks associated with stock prices.
Additionally, Bell curve cannot be appropriate for understanding market risk because market risks are not normally distributed. Market risks are usually influenced by a number of factors, such as asymmetric information or speculations. These factors that usually come into play sometimes in a sudden change in the market. As such, it would be inappropriate to use Bell curve that is only appropriate for measuring situations that are normally distributed. Mandelbrot being a strong critic of the Bell curve as a measure of risk would say that the Bell curve is not an appropriate risk analysis tool because the assumptions made under Bell curve do not reflect the reality. Black swans in markets maintain that events that have never occurred in the past render risk management based on historical information useless (Garlick 48). Accordingly, Taleb will say that market risks are not normally distributed, thus cannot be predicted using the Bell curve.
Garlick, Andy. Estimating Risk: A Management Approach. New York, NY: Gower Publishing, Ltd., 2007. Print.