Tail risk hedging (and hedging in general) has been a hot topic of discussion in recent years.

With the market rally and the VIX back down to historically low levels (~15 as of this writing), I thought it appropriate to share a paper published by AQR Capital Management in the Summer 2011 (AQR Tail Risk Hedging Whitepaper). Many thanks to the Reader who was kind enough to share this with PM Jar.

Note to Readers: AQR often defines risk as volatility. Regardless of whether you agree with this definition, the paper is a worthwhile read as AQR makes astute and interesting observations.

For example, hedging has a number of implementation challenges:

• How much one is comfortable losing (and over what period of time)
• Sizing the hedge appropriately relative to the notional value one wishes to protect
• The psychological difficulty in sticking to an insurance program after years of negative performance

Most importantly, if the goal for hedging is to alter the volatility profile of the portfolio return stream, the paper outlines a number other methods to achieve that goal without spending protection premium.