Return Distributions

Return distributions describe the frequency and magnitude of investment returns over a specific period. In traditional markets, returns are often modeled using a normal distribution, but crypto returns frequently exhibit fat tails, meaning extreme price moves occur more often than predicted by standard models.

Understanding these distributions is essential for pricing options and managing tail risk. A distribution with a high kurtosis indicates a higher probability of extreme events, such as market crashes or vertical rallies.

Traders must account for these non-normal characteristics when calculating risk metrics like Value at Risk or when designing hedging strategies. Ignoring the unique shape of crypto return distributions can lead to significant underestimation of potential losses.