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Tag: Bank of England

There’s Still Time to Hedge Tail Risk — At Least for Stocks: Kris Sidial (Szn 4, Ep. 29)

Published October 19, 2022

Kris Sidial of The Ambrus Group joins the podcast to discuss tail-risk hedging: how it works, why it’s important, and how investors can still take advantage of volatility mispricings to protect themselves against further downside — at least in stocks.

Content Highlights

  • What is tail risk hedging? (3:19);
  • Traditional hedges haven’t worked, starting with the 60:40 approach. How might investors hedge stock and bond exposure? (6:15);
  • There are numerous options for investors to protect against downturns. But it’s not always as easy as buying put contracts on indexes (8:24);
  • Variance swaps, one way to compound returns on movements in volatility (10:25);
  • Thoughts on UK pensions and what might have caused issues in that segment of the market (15:27);
  • What investors are doing in this environment in terms of tail-risk hedging — there are still opportunities to hedge (20:02);
  • Background on the guest (30:08);
  • Discussion of systemic risk as a result of the layers of options trades and counterparties: “There is a systemic hazard taking place right now in the derivatives market” (39:32);
  • Speaking of risk, what about the regulatory environment? Are regulators asleep at the switch? Reasons to believe Dodd-Frank is perhaps not as effective as people think.. (43:37)
  • Thoughts on cryptocurrencies (50:01).

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Bank of England Bail-Out and the Return of Systemic Risk

Published September 29, 2022

The following is an amended version of the Sept. 29 Daily Contrarian. This briefing and accompanying podcast are released to premium subscribers each market day morning by 0700. To subscribe, visit our Substack.

Stocks rallied yesterday after the Bank of England said it would intervene in bond markets. The central bank will buy £65 billion worth of long-dated gilts at an “urgent pace” and postpone plans for quantitative tightening. The Wall Street Journal has as good piece that gets into the quandary the BOE was in. Apparently pensions were on the hook for holding derivatives tied to interest rates.

Bank of England logo (old)
Bank of England logo (old)

Pensions, Derivatives, Systemic Risk

The BOE move was cheered by markets but it does raise questions. If pensions are behaving like hedge funds by betting large amounts of money on esoteric (and illiquid) interest rate swaps, then that would certainly introduce a level of systemic risk to the system.

If all that sounds familiar, it’s because it’s exactly what almost brought down the whole financial system in 2008. Except then it was banks trading these things, not pensions. (Okay, strictly speaking they were different instruments. But whatever, they were still derivatives. And yes, comparisons to 2008 are cheap AF. Still, this looks like an obvious similarity). They say regulators are always guilty of fighting the last war. Well, bank balance sheets are pretty clean these days. But pensions? Does anybody know what they’re even holding? And who are the counterparties?

The derivatives in question appear to be liability-driven investments, or LDIs. The size of this market? About $1.5 trillion (not a typo). This raises the very obvious question of what other pension funds in what parts of the world are trading these things.

We’ve cautioned for some time that once the whole market starts rolling over it could unearth problems that nobody had been anticipating. This is typical of market shifts of this size. Well here we go. So nice little bounce yesterday. But it would be pretty naive to think this issue is resolved and we can live happily ever after.

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