Monetization Matters: Active Tail Risk Management and the Great Virus Crisis

Abstract

The authors discuss monetization strategies for both left- and right-tail risk hedging to illustrate the potential benefits of active management of hedges. In particular, by including actual data from the sharp COVID-19 pandemic-related market correction and subsequent rebound of 2020, the authors quantify how monetization strategies have the ability to improve the performance of portfolio hedges. This extends previous work on active tail risk hedging published in this journal. The authors conclude that active management of tail hedging can result in significant increases in the efficacy of tail hedging.

TOPICS: Options, performance measurement, portfolio construction, tail risks

Key Findings

• • Simple monetization rules designed as a function of the option price can result in the full or partial sale of a hedging position that has appreciated in price.

• • Monetization strategies for both left-tail and right-tail risk hedging have the ability to improve the performance of portfolio hedges.

• • Active management of tail hedging can result in significant increases in the efficacy of tail hedging.