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What is tail risk and how does hedging supposedly protect against that?

reading about the JPMorgan incident and confused about logistics. thx

May 31, 2012 by Nikolaus from Newtonville, MA in  |  Flag
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Tail risk is technically defined as a higher-than-expected risk of an investment moving more than three standard deviations away from the mean. For mere mortals, it has come to signify any big downward move in a portfolio’s value. There are different ways to hedge tail risk, but a popular one is to create a basket of derivatives that will perform poorly during normal market conditions but soar when markets plunge. These include options on a variety of asset classes, such as equity indices and credit-default-swap indices as well as more modern volatility products. More creative advisors are using volatility as an asset class. For a more detailed explanation, read more here: http://www.pimco.com/EN/Insights/Pages/Spotlight_BhansaliTailRisk12-08US.aspx

Comment   |  Flag   |  Jun 01, 2012 from Marlton, NJ

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Tail risk refers to the chance, thought to be rare, of extreme volatility for an asset. It gets its name from the way it looks on a chart, after plotting data points. When there's high volatility, data points are spread out over a large range of values, looking like tails. Hence the name.

Hedging strategies seek to reduce losses should fears of extreme volatility happen. There is any number of ways to hedge, many are sophisticated and others are untested. But the concept is to have part of your portfolio in things that should do well if things go badly.

Comment   |  Flag   |  May 31, 2012 from Bryn Mawr, PA

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