Strategic Asset Allocation and Multi-Asset Tail Hedging
Summary
The document considers whether investors with a persistent strategic allocation, such as a balanced equity and bond portfolio, should add option based protection against severe losses. Its motivation is asymmetric: a large loss may threaten an investor’s ability to remain invested, while an equally likely favorable outcome may simply benefit the portfolio. It also raises whether tail hedges should cover both equities and bonds when valuations appear extreme.
The response offers a practitioner oriented book as a starting point, but does not develop a hedge design, compare instruments, or provide performance evidence. It briefly suggests a structured contingent payoff linked to equity and Treasury markets, without discussing pricing, sizing, basis risk, or implementation. The exchange therefore frames the allocation and hedging question but leaves the construction of a multi-asset hedge largely unresolved.
Key ideas
- Persistent strategic allocations may expose investors to losses that threaten their ability to stay invested.
- Option based tail hedges are proposed as a way to address this asymmetric downside concern.
- The document asks whether equity and bond exposures should both be hedged in extreme valuation environments.
- The response recommends further reading and mentions a cross-asset contingent payoff, but gives no construction method or evaluation.
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Full text
# Strategic Asset Allocation and Multi-Asset Class Option Based Tail Risk Hedging # Strategic Asset Allocation and Multi-Asset Class Option Based Tail Risk Hedging If a Strategic Asset Allocation is defined as an asset allocation to weather all investment environments and one which should be employed in the absence of any market views, it would appear that the 60:40 Equity:Bonds allocation fits this definition, given the persistence of such an allocation by real money investors. If such an allocation is persistent and such investors are required to maintain full investment, would a tail hedge be a good strategic investment in light of the fact that asset allocations are being probabilistically driven but only one path of history is realized? It would appear that there is asymmetric risk in that a bad outcome could mean the end of the game, while an equally probable good outcome is only beneficial to such investors. It seems to have option like features and risks that an options based tail hedge would mitigate. A tail hedge would be appear to be even more important if there are bubble like conditions. In an environment where both bonds and equities seem to be at extremes, and the Strategic Asset Allocation maintained, should both asset classes incorporate a tail hedge? How could a multi-asset class option based tail hedge be constructed? What instruments would one use? ## Answer by user42108 (score 1) https://quant.stackexchange.com/a/58244 As a starting point, you might want to read "TAIL RISK HEDGING: Creating Robust Portfolios for Volatile Markets", by Vineer Bhansali (2013). The author runs a tail risk fund (LongTail Alpha) so you will at least get a practitioner's perspective. [EDIT: I avoided saying more because your questions are very broad. If you want a "multi-asset class option based tail hedge", talk to your friendly neighborhood structurer and ask for a dual digi on SPX and CMT10!]
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