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By: joeenuf Tue, 05 Jul 2011 22:56:27 +0000 many years ago, my dad read an amazing statistic in, I think the NYTimes, but it might have been some other, at the time well respected, source of news.
The statistic was that 30% of vietnam vets attempted suicide – which if you think about it for a few seconds, is an amazing number.
My dad snailmails (this is way, way before the web) the reporter, who sends him to a “source” who sends him to another source…eventually, my dad gets a Prof of Clin Psychiatry at the San Diego Veteran’s med center on the line, who, according to my dad, starts screaming, those bastards, they’ve been misquoting me for months, its 30% of Viet Vets hospitalized for acute psychosis who attempt suicide..which is roughly the same as the general population.
Or, never attribute to motive what can be explained by stupidity, or as Pascal is reputed to have said, it is easy to understand infinity, just contemplate human stupidity

By: ErnieD Tue, 05 Jul 2011 15:42:37 +0000 I think there are two parts to the question,

The first part, hedging tail-risk of a defined distribution, is what Wall Street claims to have lots of products to do. They accomplish this with varying success.

The second part, is the “black swan” type of event which is a completely different animal.

How do you hedge against the Weimar Republic hyper-inflation, the destruction of your country like most of Europe and Japan saw in WW II, the take-over of your country by a foreign power, such as the Iron Curtain countries, internal revolution (France late 1700s, Iran 1979), the collapse of a banking system (US 1929-33), civil war (US 1860s), etc.

These types of events require “products” much different from anything that Wall Street purveys. Jews in Germany in the 1930s needed Swiss bank accounts, diamonds, and an exit visa from the country, similarly for the ruling elite in Iran in 1979 and France in the 1700s.

Survival in the early years of the Great Depression required no debt and lots of cash under the mattress, not in a bank. Even owning farmland didn’t necessarily help due to the massive drought and topsoil loss, partially due to poor farming practices.

Ultimately, hedging “tail risk” can involve everything from having some shorts to owning a shotgun and shells under the bed along with cans of food and gold pieces.

Bill Bernstein at did a good piece on tail risk in about 2000 when he estimated that the best that the various retirement calculators could do for actual confidence level was about 80% instead of the 95% that most touted because the potential of major events like war and societal collapse during a lifetime does not show up in any MPT statistics.

By: jomiku Tue, 05 Jul 2011 00:39:38 +0000 It’s clear from looking at the comments, including my own, that we’re talking about two different forms of tail risk. One is the 3 standard deviations move from a price. That can be hedged because it can be modeled and priced. Another is what are now called black swans but which also be called that which the model doesn’t predict can happen; either the probability is too low, the risk is already hedged in the strategy being modeled or it simply can’t be anticipated. I imagine one can hedge one’s hedge one’s hedge but one can’t overcome the biases inherent in models that make one blind to unanticipated, even unimagined risk.

By: SelenesMom Mon, 04 Jul 2011 23:39:18 +0000 It looks to me as though there is a “tail risk hedge,” except that I don’t fully understand how to pull it off. If I did, I’d consider doing it myself and building near risk-free wealth.

It involves first becoming a well-known fund manager, but not necessarily one who can survive both up and down markets. Then somehow, after you blow up, like Meriwether or apparently like this Boaz Weinstein Felix mentions, you persuade people to set you back up in business anyway, and you still have a nice income.

By: Danny_Black Mon, 04 Jul 2011 06:00:48 +0000 mwwaters, the irony of course of you mentioning Howie is that his trade was predicated on a crash in house prices. He was the one making a “Big Short”. Of course he didn’t want to be losing 100s of millions a year for what would have been 3 years so he funded it with writing insurance on AAA tranches and when correlations went to one he lost a bundle.

Just goes to show you can be right about the future and still lose money.

By: y2kurtus Mon, 04 Jul 2011 00:27:58 +0000 I agree that tail risk can’t be hedged.

I think a related topic of great interest the next few weeks will be what is truely the worlds most investable ultra low risk asset. Curently the market says it’s U.S. T-bills and German Euro Bonds.

I’m on the other side of that trade… put my money into ultra-high quality equities which generate meaningful %’s of their earnings in several currencies and who’s dividends (untaxable to me in IRA’s) are higher than the 10 year treasury. Like TFF I’m more worried about the dependability of the cashflows than the day to day volitility of the principal.