Kass: Why a 25% Drop Isn't Out of the Question

The S&P/LSTA Leveraged Loan Index was established 10 years ago. Its monthly return over the 127 months has averaged 0.42%, with a standard deviation of 0.63%. So July's loss of 3.35% was over six standard deviations from the average. The largest monthly move prior to July was a loss of 1.51% in September 2001; this was 3.6 standard deviations from the average return.

Let's put the Loan Index's move into an equity perspective over the same 10.5 years and calculate what a six-sigma event would mean for equities.

Since 1997, equities have produced an average monthly return of 0.79%, with a standard deviation of 4.36%. There has never been a six-sigma event in that time frame. The largest monthly price change was a 14.5% loss in August 1998 (during Long Term Capital Management's demise); this represented over 4 standard deviations from average returns.