The Statistical Anomalies of Finance

In studying the patterns that underpin the frequency of an event occurring versus not occurring; we miss out on the statistical anomalies of rare phenomena. When things in our businesses do not fit into our known patterns, panic tends to ensue.

There is a flower in the natural world that is known as the corpse flower. It is found in Indonesia. The Latin name is Amorphophallus Titanum. It has been described as a freak of nature due to its low probability of occurrence.

And yet, such a phenomena occurs in the natural world.

The corpse flower generally requires 5 through 10 years of vegetative growth before blooming for the first time. After a plant’s initial blooming, there can be considerable variation in its blooming frequency. Some may not bloom again for another 7 to 10 years while others may bloom every two or three years.

The term anomaly is derived from Greek. It means uneven or irregular. In statistics, anomalies are often referred to as outliers. For a given data set, if we plot a graph and observe–all the data points that are relative to each other will be plotted densely–whereas some data points which are ‘different’ to the data set will lie away from the rest of the points. A bit like our corpse flower.

These are known as deviations from the mean or deviations from what is ‘normal’ or ‘average’. Statistical approaches are largely modelled or theoretically based approaches. A model is utilised to analyse the data and objects are calculated with respect to how they are relative with all other objects.

One statistical anomaly that is discussed in the world of finance is the reversal of the known trend. Some evidence suggests that stocks at either end of the performance spectrum can and do tend to reverse course in the following period—yesterday’s top performers become tomorrow’s under-performers and vice versa.

By studying anomalies, we realise an underlying statistical pattern within the anomalies themselves. The statistical evidence backs this up. If a stock is a top performer, odds are that its high performance has made it expensive. The reverse is also true for under-performers.

The pattern will also reverse back, later on. Just something to think about.

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