PIMCO On Hedging: It Pays To Be Countercyclical

Authored by Vineer Bhansali of PIMCO, Tail Risk Hedging: It Pays to Be Countercyclical It is a well-known phenomenon that quiet markets, low volatility and a lack of visible risks on the horizon can lead to complacence and increasingly dangerous, leveraged positions. In doing so, these market conditions set the stage for the next cycle of deleveraging and losses. What has also become apparent is a predictable behavioral response to this cycle. When the markets experience large losses, tail risk hedging comes back into fashion, leading to an old-fashioned surge in demand that drives up volatilities across markets. This in turn reduces the overall effectiveness of naïve hedges, and means one has to be smart about when and where to spend hedging premiums. On the other hand, when markets are quiet, investors can quickly forget the pain suffered during prior crises, and may choose to elimina...