A primer on tail risk hedging

Abstract

Deleveraging and sovereign debt crises in the developed world, risks of hard landing in emerging market economies, and questions around the stability of the global financial system increasingly compel investors to consider ways of protecting their portfolios against extreme tail events. This paper discusses the various types of tail risk, how investors may want to think about them, and what hedging options may be available. For most market participants, the discussion of tail risk hedging has historically centred on static or passive hedges. While these strategies are relatively simple to understand and implement, they tend to be quite expensive and inefficient over time. This paper highlights the benefits of an active and diversified approach to tail risk hedging, which can be a more attractive and cost-efficient alternative.