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Come on, every finance guy knows to cut off tail risk, yet they still don't. Look at LTCM, with all the brains they had still didn't cut off tail risk and Meriw
by nashequilibrium 12y ago
Come on, every finance guy knows to cut off tail risk, yet they still don't. Look at LTCM, with all the brains they had still didn't cut off tail risk and Meriwether still came back and got burnt again. Look at Victor Niederhoffer, got burnt twice the exact same way not cutting off tail risk. Then you get a guy like Taleb profiting off tail risk. Complaining about liquidity crunches does not count as its one of the main parts of the tail risk.
- encoderer 12y agoWhat you're talking about is a hedge. Hedges are expensive. A better strategy to a lot of investors is to "hedge" by trading smaller. Of course the spectacular failures you name were spectacular because they weren't hedged and were done with immense leverage. There is no way looking forward to predict if a hedge that eats 1/2 your returns every year is a better investment than just taking a catastrophic loss every several years. And it's not as simple as taking a 50% haircut on every trade: in reality maintaining a hedge will turn many of your small winners into losers. I personally guard against the prospect both by staying small (trading with only a small portion of my total account) and by maintaining net short deltas (beta-weighted). Keeping short deltas in a bull market with upward drift also has a cost, but it lets me sleep easier at night.
- nashequilibrium 12y agoBottom line, mean reversion strategies will bite you in the ass at some point.
- encoderer 12y agoI think it's clear that price isn't mean reverting. Vol, on the other hand, I think is.