The assumption that most of the risk in real life situations can be depicted by normal curve fails under many cases. A small difference in the real risk faced by an asset class than that shown by normal curve gets coupled with risk faced by another interacting asset class and it leads to a multiplier effect. Thus the overall risk faced by an economy can be enormous due to this multiplier effect and it leads to financial crisis when the system is stretched beyond the risk tolerance limits. This happens in the case of asset bubbles when prices increase significantly that real market valuation faces huge uncertainty.
It distorts market as it encourages speculation thus building up of upward spiral of prices which are unsustainable as they are not suported by real wealth. This huge uncertainty results in high risk to an economy as an asset bubble affects other asset classes through the financial markets. Finally the bust follows as market discovers real value of an asset and in the process a large share of investor wealth gets eroded. Thus we need an effective model which can help us to price the risk element in the financial world with required accuracy levels.A lot of work needs to be done in this field to upgrade our risk management models and replace them with better ones.
