The Fat Tail: The Power of Political Knowledge For Strategic Investing - Fat Tails

Fat Tails

As William Safire notes in his recent etymology of the term, a fat tail occurs when there is an unexpectedly thick end or “tail” toward the edges of a distribution curve, indicating an irregularly high likelihood of catastrophic events. This fat tail represents the risks of a particular event occurring that are so unlikely to happen and difficult to predict that many choose to ignore their possibility. Political impacts are often reduced to a rounding error in conventional risk analysis; as a result, many actors affected by political risk do not adequately plan for it. This book argues that political risk can be analyzed, understood, and mitigated—and often predicted.

One example that Bremmer and Keat highlight in The Fat Tail is the August 1998 Russian devaluation and debt default. Leading up to this event, economic analysts predicted that Russia would not default because the country had both the ability and willingness to continue to make its payments. However, political analysts argued that Russia’s fragmented leadership and lack of market regulation—along with the fact that several powerful Russian officials would benefit from a default—reduced Russia’s willingness to pay. Since these political factors were missing from the economic models, the economists did not assign the correct probability to a Russian default.

The Fat Tail is an introduction to integrating such political factors in risk analysis and strategic planning. It is an effort to bring politics out of the error term and into the strategic planning models of investors, corporate decision-makers and policymakers.