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Parallax volatility advisers tail hedging skin#

The difference between a negative and positive skew can be illustrated like this: We have previously written an article that covers negatively skewed trading strategies. Watch the trader who makes consistent money. Negatively skewed vs positively skewed distributions Opposite, right tail risk (right fat tails), are unexpected positive outcomes. Hence, it’s frequently referred to as left tail risk. If we look at a probability distribution, the unwanted tail risk is normally on the left side of the distribution curve and happens more frequently than a normal distribution suggests. Hence, tail risk is something that is rare and seldom and “hidden” in the corners (the tails).

Parallax volatility advisers tail hedging skin#

This is what Taleb writes in Skin In The Game” about tail risk:įor, as with financial traders, the best place to hide risks is “in the corners”, in burying vulnerabilities to rare events that only the architect (or the trader) can detect – the idea being to be far away in time and place when blowups happen. But statistical studies of financial markets indicate “freak events” have fat tails. Any Monte Carlo simulations of sets of coin tosses are less likely to deviate from the long-term mean of a 50% chance for head or tail. Why? Nassim Nicholas Taleb, the author of The Black Swan and seen as the mastermind behind the philosophy of tail risk, argues that random huge movements in the financial markets happen more frequently than the normal distribution indicates.įor example, 1000 coin tosses are a perfect example of a normal distribution. We can argue that fat tails are a more realistic outcome of an event. But the fat tail distribution might indicate otherwise and subsequently, the trader underestimates the risk he is taking. If a trader or investor uses the blue line as the expected outcome, he might be filled into believing the risk is much lower than it actually is.

In order to better understand the concept we made a chart to explain the difference between a normal distribution (bell curve) and a fat tail distribution: Tail risk is often referred to as “ fat tails“. What is tail risk? What is a fat tail? What is tail distribution?

Tail risk strategies are difficult because we are risk-averse.

Our own experience of tail risk hedging strategies.

How has Cambria’s Tail Risk ETF performed during a crisis? Does tail risk hedging work?.

Hedging tail risk strategy example: Cambria’s TAIL ETF (backtest).

Trend following as tail risk hedge strategy.

Ray Dalio’s All Weather Portfolio (All Weather Principles).

Tail risk ETF (ticker: TAIL): Meb Faber and Cambria’s tail risk ETF.

Put options as a hedge against tail risk.

Tail hedging strategies: How do you hedge against tail risk?.

Hedge against tail risk to avoid behavioral mistakes.

Why do you want to hedge against tail risk?.

Negatively skewed vs positively skewed distributions.

What is tail risk? What is a fat tail? What is tail distribution?.

Hence curious if there's some standard risk management bible for vol groups. Its fascinating to me because traditional risk measures don't work well, market exposure as described in marketing documents I've seen primarily talk about VaR at 95/99 but that is useless in sudden vol spikes like in Feb/Mar yet numerous short vol groups have weathered the storm (I'm at least certain those PMs still have jobs!). I meant groups for vol arb (essentially non market-making groups at prop shops and large platforms).

though I believe that Artemis can also be short vol. Huge fan of Cole and Artemis btw (Taleb's a bit too incendiary.). However, like you say its hard to consistently make money like this and it has very low Sharpe (but probably much better risk profile). Essentially looking for mispricings related to events. Essentially former flow traders at banks that moved over and wanted more PnL. The only successful long vol 'groups' were traders at prop shops / market-makers that were given a book. Though learning that they had a short vol operation makes me question how much that performance was due to vanilla market neutral equities book. Probably not quite on the level of PDT/DeShaw but very strong. they were always seen as quite innovative in the quant equity space and their returns were significantly superior to competitors. Still surprising Voloridge is in the options space! Though it does explain the outsized returns of las couple of years.