Study on the Existence of Fat-Tail Phenomena in the Korean Stock Market (Apr 4, 2019)

created At: 3/17/2025

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Fact

Fat tails have become more prominent: More pronounced in recent periods. Increased market volatility and frequency of unexpected shocks. Stronger in small-cap stocks: More speculative trading, information asymmetry, and sentiment-driven movements than large-cap stocks. Market crashes contribute but are not the sole cause: 1997 financial crisis amplified fat tails, but they persist beyond crisis periods. Volatility clustering alone does not explain fat tails: Fat-tail phenomena remain even after controlling for volatility with GARCH models. Asymmetric tails: Positive fat tails (sharp price surges) are thicker than negative ones (sharp declines).

Opinion

This study provides empirical evidence that fat tails are becoming more significant in the Korean stock market, especially in small-cap stocks. The inability of traditional volatility models (e.g., GARCH) to fully capture fat tails suggests limitations in conventional financial theories. The fact that positive fat tails are more pronounced is particularly noteworthy, as it suggests that sharp price surges occur more frequently than steep declines. This challenges the typical assumption that markets are more prone to crashes than rallies. Investors should develop risk management strategies that account for both market crashes and unexpected price surges rather than relying solely on traditional risk models.

Core Sell Point

The fat-tail phenomenon is becoming stronger in the Korean stock market, particularly in small-cap stocks. Since traditional volatility models fail to fully explain it, investors must consider both market crashes and sharp rallies in risk management strategies.

"Fat Tails in Financial Return Distributions Revisited: Evidence from the Korean Stock Market"
This study examines the fat-tail phenomenon in the Korean stock market using historical data and various statistical methods.

1. Research Objectives

Empirically verify whether fat-tail phenomena exist in the Korean stock market.
Investigate whether fat tails have become more pronounced in recent years and whether they are stronger in small-cap stocks.
Analyze the impact of the 1997 Asian financial crisis and volatility clustering on fat-tail distributions.

2. Research Methodology

Used daily log returns from January 1980 to June 2015.
Divided the dataset before and after the 1997 financial crisis and categorized stocks by market capitalization.
Compared actual return distributions with theoretical distributions (normal distribution, Student’s t-distribution, and alpha-stable distribution).
Applied the GARCH model to control for volatility clustering.
Measured tail fatness using statistical probability and degrees of freedom from the Student’s t-distribution.

3. Key Findings

Fat tails have become more pronounced in recent periods:

Compared to the pre-crisis era, fat-tail effects have intensified in recent years.
Suggests that market volatility has increased and that unexpected shocks occur more frequently, making the investment environment less predictable.

Fat tails are more prominent in small-cap stocks:

Fat-tail distributions are stronger in small-cap stocks than in large-cap stocks.
This can be attributed to higher information asymmetry, speculative trading, and greater influence of market sentiment in small caps.

Market crashes significantly contribute to fat tails:

Fat tails are evident during financial crises, such as the 1997 Asian financial crisis.
However, even after controlling for crisis periods, fat tails persist, indicating that other factors also contribute to fat-tail phenomena.

Volatility clustering does not fully explain fat tails:

Even after controlling for volatility clustering using the GARCH model, fat tails remain significant.
This suggests that traditional volatility models cannot fully explain fat-tail behavior, and additional factors are at play.

Asymmetry between positive and negative tails:

In the Korean stock market, positive fat tails tend to be thicker than negative ones.
While large losses are often seen in negative fat tails, the market experiences more frequent large positive price movements.

Conclusion

This study confirms that fat-tail phenomena exist in the Korean stock market and cannot be fully explained by market crashes or volatility clustering.
Fat tails indicate that extreme gains and losses occur more frequently than predicted by normal distribution models, making them a crucial factor in risk management. Future research should focus on identifying systematic and unsystematic risks embedded in fat-tail behavior.

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1. Research Objectives

2. Research Methodology

3. Key Findings

Conclusion

[Compliance Note]