TAIL RISK HEDGING: Creating Robust Portfolios for Volatile Markets

by Vineer Bhansali

"TAIL RISKS" originate from the failure of mean reversion and the idealized bell curve of asset returns, which assumes that highly probable outcomes occur near the center of the curve and that unlikely occurrences, good and bad, happen rarely, if at all, at either "tail" of the curve. Ever since the global financial crisis, protecting investments against these severe tail events has become a priority for investors and money managers, but it is something Vineer Bhansali and his team at PIMCO have been doing for over a decade. In one of the first comprehensive and rigorous books ever written on tail risk hedging, he lays out a systematic approach to protecting portfolios from, and potentially benefiting from, rare yet severe market outcomes.

Tail Risk Hedging is built on the author's practical experience applying macroeconomic forecasting and quantitative modeling techniques across asset markets. Using empirical data and charts, he explains the consequences of diversification failure in tail events and how to manage portfolios when this happens. He provides an easy-to-use, yet rigorous framework for protecting investment portfolios against tail risk and using tail hedging to play offense. Tail Risk Hedging explores how

Generate profits from volatility and illiquidity during tail-risk events in equity and credit markets Buy attractively priced tail hedges that add value to a portfolio and quantify basis risk Interpret the psychology of investors in option pricing and portfolio construction Customize explicit hedges for retirement investments Hedge risk factors such as duration risk and inflation risk

Managing tail risk is today's most significant development in risk management, and this thorough guide helps you access every aspect of it. With the time-tested and mathematically rigorous strategies described here, including pieces of computer code, you get access to insights to help mitigate portfolio losses in significant downturns, create explosive liquidity while unhedged participants are forced to sell, and create more aggressive yet tail-risk-focused portfolios. The book also gives you a unique, higher level view of how tail risk is related to investing in alternatives, and of derivatives such as zerocost collars and variance swaps. Volatility and tail risks are here to stay, and so should your clients' wealth when you use Tail Risk Hedging for managing portfolios.

PRAISE FOR TAIL RISK HEDGING:

"Managing, mitigating, and even exploiting the risk of bad times are the most important concerns in investments. Bhansali puts tail risk hedging and tail risk management under a microscope--pricing, implementation, and showing how we can fine-tune our risk exposures, which are all crucial ways in how we can better weather our bad times." -- ANDREW ANG, Ann F. Kaplan Professor of Business at Columbia University

"This book is critical and accessible reading for fiduciaries, financial consultants and investors interested in both theoretical foundations and practical considerations for how to frame hedging downside risk in portfolios. It is a tremendous resource for anyone involved in asset allocation today." -- CHRISTOPHER C. GECZY, Ph.D., Academic Director, Wharton Wealth Management Initiative and Adj. Associate Professor of Finance, The Wharton School

"Bhansali's book demonstrates how tail risk hedging can work, be concretely implemented, and lead to higher returns so that it is possible to have your cake and eat it too! A must read for the savvy investor.

Genres: Finance

273 pages, Kindle Edition

First published December 6, 2013

Reviews

[PF Chang · Rating 3 out of 5]

Could have been 4 stars, but the lack of basic statistical rigor is outrageous.

Very early on in Ch. 3, the author got the relationship of median and expected return wrong (P. 53).

Later in Ch. 8, when discussing maximum drawdown he seems to be completely oblivious to the fact that drawdown is closely related to the 'memory' of the time series, and hence the moments (which only carry information about period to period change) do not shed light on drawdown structures.

[Cody Rioux · Rating 5 out of 5]

Bhansali provides a concise and practical framework for hedging tail-risk in equities and shows the reader how to extend the framework for other risk factors via an example in hedging duration (interest rate/inflation) risk. I really consider this to be the practical companion to the mathematical concepts laid out in Taleb’s The Statistical Consequences of Fat tails. The two authors certainly don’t agree on everything but if you read Taleb and wondered how to practically implement things this book will give you a start.

Would love to see this updated with new data and scenarios with everything that has happened since publication (COVID, 2022, inflation).

I really recommend this to anyone interested in tail risk hedging, but definitely read Taleb as well and decide for yourself what you can take away.

[Panji Aryaputra · Rating 4 out of 5]

Good book, I feel. But the lack of necessary background make me unable to fully appreciate its contents.

[Cong Ge · Rating 5 out of 5]

wonderful book

It is very useful especially this year considering current market situation. Tail risk hedging may be a must for good investors in following years.