Gustavo Ballvé on August 25th, 2010
Food for thought, Home, Portfolio Management, Risk management, Signal or Noise

Relatively clueless weekend articles by the Wall Street Journal. This one, ‘Preparing for the next Black Swan‘, is downright scary in the number of supposedly “heads I win, tail you lose” hedging/ ‘black swan-proof’ strategies currently pushed to customers – increasingly retail customers on top of the institutional ones. To be clear: we’re all for capital preservation, and our company’s success is built more on the back of risk aversion than of risk-taking. However, the article doesn’t do nearly enough to highlight that hedging instruments or strategies, especially untested ones, have not only flaws (have we already forgotten counter-party risk in 2008?) but most importantly costs, sometimes hidden, and in no way are these costs of a fixed nature.

This has all the tell-tale signs of a fad… The scariest bit is the description of an instrument sold by a big bank: “(…) It is designed to post small returns in most markets, (..) but in very dramatic times, that bet gets amplified.” Well, good luck with that when the next storm breaks.

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