No. of Recommendations: 2
Mike:

Most financial models including the Black-Scholes option pricing model assume that prices have a normal or bell shaped distribution. This is not so, prices exhibit a power law distribution which means that the outliers, the tails of the bell curve, are a lot fatter than in a normal distribution. Nicholas Taleb Nissim discussed this under the concept of "Black Swans"

http://www.amazon.com/Black-Swan-Impact-Highly-Improbable/dp/1400063515
http://en.wikipedia.org/wiki/Black_swan_theory

and Benoit Mandelbrot talks about it in The Misbehavior of Markets:

http://www.amazon.com/Misbehavior-Markets-Benoit-Mandelbrot/dp/0465043550

Earthquakes, avalanches and many other natural phenomena follow the power law distribution: a few big ones, more middling ones and lots of small ones.

http://en.wikipedia.org/wiki/Power_law

A sandpile is a good model of the power law, as you add grains of sand, you get various sizes of avalanches.

Denny Schlesinger
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