We love maps. We also love talking about standard deviation. Combine the two and… well, we can’t help ourselves. Check out this map showing the standard deviation of national temperatures from last week (credit: weatherunderground.com):
We recently posted on the fact that the world of finance is not normally distributed, but it’s an important concept to remember. In this case, if the weather behaved the way financial markets do, we’d live in a very terrifying world – the world Nassim Taleb dubbed “Extremistan” in his wonderful book Black Swan. For example, on October 19th, 1987 the S&P 500 hit a low of 224.83, which was -20.47% down from the previous day’s close of 282.7. That drop was more than 24 standard deviations below the mean.
March 20th was definitely hot, but if it had been 24 standard deviations above normal, it would have been about 285 degrees, hot enough to boil the water of Lake Michigan, or literally fry an egg on the sidewalk. Conversely, if that day had been 24 standard deviations below the mean, it would have been -195 degrees, substantially colder than the coldest night ever recorded in Antarctica (-128.6 degrees).
Fortunately, temperatures are normally distributed, so we don’t have to worry about bursting into flames or freezing on the spot when we leave the office. However, don’t expect financial markets to behave the same way. As we’ve said before, the markets operate in Extremistan, and if you aren’t careful you can get seriously burned.