Explanation

A QQ (Quantile-Quantile) plot is used to compare the distribution of a dataset to a theoretical distribution (typically the normal distribution). In a QQ plot:

• If the data points fall approximately along the reference line (45-degree line), the data is normally distributed
• If the data points curve upward at the ends, it indicates fat tails (more extreme values than expected in a normal distribution)
• If the data points curve downward at the ends, it indicates thin tails (fewer extreme values than expected in a normal distribution)

Since the question asks which statement is correct based on examining the QQ plot, and option D states "The return distribution has fat tails relative to the normal distribution," this would be the correct interpretation when the QQ plot shows points deviating above the reference line at both ends.

Key points:

• Fat tails = more extreme values = data points above the reference line at both ends of QQ plot
• This is common in financial returns data, which often exhibit leptokurtosis
• Fat tails indicate higher probability of extreme events than predicted by normal distribution
• This has important implications for risk management as it means traditional VaR models based on normal distribution may underestimate tail risk