Black Swans, Broccoli, and Barbells

Open Access
Fong, Hortense
Area of Honors:
Bachelor of Science
Document Type:
Thesis Supervisors:
  • Louis Gattis Jr., Thesis Supervisor
  • James Alan Miles, Honors Advisor
  • Asset allocation
  • Fractal
  • Black swan
  • Barbell Trading Strategy
The field of finance is a relatively young one. The market and our financial models are essentially all part of one great experiment that nobody can predict the outcome to. With limited years of financial data, we resort to the method of trial and error. Time and again, we have used the normal curve to model the changes in asset prices and time and again, we have been fooled by the curve. The normal distribution does not model asset price changes well because of extreme black swan events. These events are near impossible according to our normality-assuming models and cause great damage in the market. As a result, if we believe that the financial market can be modeled, we must begin considering alternatives. One such alternative is the multifractal model proposed by Benoit Mandelbrot. The model is often seen in nature, such as in broccoli stalks, and appears to account for many characteristics of asset price changes the normal model cannot. If we are to reevaluate our financial models, we must also reevaluate the implications of our models, specifically our asset allocation strategies. Our current asset allocation strategies assume normal price movement behavior and thus leave us highly vulnerable to market crashes. The barbell strategy is an alternative asset allocation scheme proposed by Nassim Taleb where 90-95% of one’s assets are put in low-risk securities, such as T-bills and T-bonds, and 5-10% of one’s assets are put in high-risk securities, such as options. After running simulations using historical data, it was found that such a strategy’s performance depends on the time period it is implemented. Using a period of over 85 years (1928-2012) yielded a negative return. Using a period of 13 years (2000-2012) yielded a positive twofold return. The use of the barbell strategy thus depends on one’s outlook on the market. Will it continue to be volatile or was the financial market of this millennium an anomaly? We must continue to question the assumptions of our models and refine them, in hopes of better measuring risk.