An Economist Walks Into a Brothel: And Other Unexpected Places to Understand Risk

by Allison Schrager

The asymmetric shape shows how risky and unpredictable the movie business is. If there’s a normal distribution and the center falls on breaking even, there are an equal number of profit-making and money-losing scenarios, and most movies fall within a close range of breaking even. With a positive-skewed distribution, like the previous one illustrating the movie business, the range of possibilities is large; there are far more profitable scenarios than money-losing ones. Notice the long tail on the right, which covers the range of potential positive profits. A movie in this range could barely break even or return more than 1000 percent, or anything in between. All the profitable scenarios are equally unlikely. The odds are a movie will lose money because most are clustered in the smaller, loss part of the curve. Fifty-three percent of movies shown don’t earn back production budgets at the box office, and that’s assuming they are shown in many theaters (most movies aren’t). And even if they do make a profit at the box office, their earning potential looks like a complete crapshoot with only a few big winners. “Skewness” poses problems for measuring risk. For volatility to tell what will happen most of the time, you need a normal, symmetric distribution. If your distribution is skewed, volatility underestimates risk; it might only tell you what will happen 30–40 percent of the time. The long tail contains a huge range of possibilities; all are nearly equally probable and unlik...