Finding the value in tail hedges

The right balance

In financial markets, events that occur far outside of expectations are often characterised as tail events. They typically increase the level of volatility in the market, and they can happen both on the upside and the downside.

When the investment community is largely positioned for asset price appreciation, the downside risk (left tail) is feared more. At 1798, we are long-term believers in the value added of left tail hedging, and we have developed a range of convex solutions that aim to benefit from tail scenarios.

The key question is whether the protection benefits outweigh the expense. In short, investors need to find the right balance between the cost in benign environments and returns in periods of tail.

In this paper, we discuss our approach to building effective tail protection.

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