Tail Risk: Challenges, Mitigation, and Research Opportunities

Abstract

This article discusses the multifaceted topic of tail risk. Topics include tail-risk perception, portfolio and enterprise management, and mitigation. We start by summarizing the key insights of the authors who have contributed to this special issue on tail risk and the applications of this work. We then propose a simple rule of thumb to evaluate tail-risk exposure and the viability of hedging strategies in the portfolio context. We add to the menu of these strategies by introducing the idea of whether protection on idiosyncratic risk is a cost-effective hedge against systemic risk. Empirical evidence and the dynamics that unfold during a systemic crisis appear to collectively indicate that the market may misprice the systemization of idiosyncratic risk. The evidence is compelling enough to warrant further research into the basis between idiosyncratic and systemic risk amid stress.

TOPICS: Tail risks, portfolio construction, financial crises and financial market history