Thursday, April 5, 2012

go short on tail-risk -- my take

Many sell-side [1] traders are described as being short tail-risk. In other words, they go short on tail-risk.

[1] some hedge funds too

*** If you are long tail-risk (insurance buyers), you are LONGING for it to increase. You stand to profit if tail risk increases, such as underlier moving beyond 3sigma. Eg -- buy deep OTM options, buy CDS insurance.

*** If you are short tail-risk (insurance sellers), you hope tail risk drops; you mentally downplay the extreme possibilities; you stand to Lose if tail risk actually escalates. Eg -- sell OTM options, sell CDS insurance agressively (below the market).

As a result, you would earn premiums quarter after quarter, but when an extreme tail risk does materialize, your loss might not be fully compensated by the premiums, because the insurance was (statistically) underpriced, because you underestimated the probability and magnitude of tail risk.

Maybe you (the trader) is already paid the bonus, so the consequence is borne by the insurance seller firm. In this sense, the compensation system encourages traders to go short on tail risk.

No comments:

Total Pageviews

my favorite topics (labels)

_fuxi (302) _misLabel (13) _orig? (3) _rm (2) _vague (2) clarified (58) cpp (39) cpp_const (22) cpp_real (76) cpp/java/c# (101) cppBig4 (54) cppSmartPtr (35) cppSTL (33) cppSTL_itr (27) cppSTL_real (26) cppTemplate (28) creditMkt (14) db (65) db_sybase (43) deepUnder (31) dotnet (20) ECN (27) econ/bank` (36) fin/sys_misc (43) finGreek (34) finReal (45) finRisk (30) finTechDesign (46) finTechMisc (32) finVol (66) FixedIncom (28) fMath (7) fMathOption (33) fMathStoch (67) forex (39) gr8IV_Q (46) GTD_skill (15) GUI_event (30) inMemDB (42) intuit_math (41) intuitFinance (57) javaMisc (68) javaServerSide (13) lambda/delegate (22) marketData (28) math (10) mathStat (55) memIssue (8) memMgmt (66) metaProgram` (6) OO_Design (84) original_content (749) polymorphic/vptr (40) productive (21) ptr/ref (48) py (28) reflect (8) script`/unix (82) socket/stream (39) subquery/join (30) subvert (13) swing/wpf (9) sysProgram` (16) thread (164) thread_CAS (15) thread_cpp (28) Thread* (22) timeSaver (80) transactional (23) tune (24) tuneDB (40) tuneLatency (30) z_ajax (9) z_algoDataStruct (41) z_arch (26) z_arch_job (27) z_automateTest (17) z_autoTrad` (19) z_bestPractice (39) z_bold (83) z_bondMath (35) z_book (18) z_boost (19) z_byRef^Val (32) z_c#GUI (43) z_c#misc (80) z_cast/convert (28) z_container (67) z_cStr/arr (39) z_Favorite* (8) z_FIX (15) z_forex (48) z_fwd_Deal (18) z_gz=job (33) z_gzBig20 (13) z_gzMgr (13) z_gzPain (20) z_gzThreat (19) z_hib (19) z_IDE (52) z_ikm (5) z_IR_misc (36) z_IRS (26) z_javaWeb (28) z_jdbc (10) z_jobFinTech (46) z_jobHunt (20) z_jobRealXp (10) z_jobStrength (15) z_jobUS^asia (27) z_letter (42) z_linq (10) z_memberHid` (11) z_MOM (54) z_nestedClass (5) z_oq (24) z_PCP (12) z_pearl (1) z_php (20) z_prodSupport (7) z_py (31) z_quant (14) z_regex (8) z_rv (38) z_skillist (48) z_slic`Problem (6) z_SOA (14) z_spring (25) z_src_code (8) z_swingMisc (50) z_swingTable (26) z_unpublish (2) z_VBA/Excel (8) z_windoz (17) z_wpfCommand (9)

About Me

New York (Time Square), NY, United States
http://www.linkedin.com/in/tanbin