How can investors identify the tail risks in their portfolios?
Bhansali: It is very hard to identify in advance what – and how severe – specific tail risks will be, and in fact that is not our primary goal when hedging tail risk. The important thing to remember is that while tail risks may vary widely in their origins, they all tend to pose similar macro risk and can have comparable impact on investment portfolios. We find that nearly all tail risks are systemic risks in which every investor desires liquidity – the ability to trade easily – but nobody is willing to provide it. Times of severe market stress often challenge traditional risk diversification models, because these periods may simultaneously exhibit substantial equity market declines, credit spread widening, increased market volatility and disorderly moves in the currency markets. By their nature, these are macroeconomic risks, because they have a very high correlation with monetary policy. This correlation allows risks to be broadly hedged at the portfolio level, rather than at the sec
