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Difficulty: Hard
Category: Probability & Statistics
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Topics: stable-distribution, modern-portfolio-theory, variance, heavy-tails
Your team employs a model where asset returns are assumed to follow a stable distribution with index $ \alpha < 2 $. Recall that stable distributions are characterized by four parameters: location, scale, skewness and index (also called characteristic exponent). What fundamental assumption of Modern Portfolio Theory (MPT) is most significantly violated when asset returns follow such a distribution?
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