macrocephalopod

What are your thoughts on *why* tail hedging works? Finance 101 says OTM put vols shd be bid up until impact of tail hedge on your portfolio was ~0; if not then short OTM puts have a negative risk premium — seems counterintuitive!

Why it *has* worked. Include the GFC in your back test to help sell it as a strategy. Everything is function of price.

It true. I guess what I want to know is what’s the story for why it will continue to work in the future (ie why are puts still priced low enough that they will help rather than hurt the geometric return). Is it outlier blindness (behavioral) or is there a structural reason?

Hard to get paid on negative expected value trades that payoff once a decade.

Which is why these are marketed on their negative covariance to a portfolio. The interesting question is how much expected value should you pay away for the diversification benefit,

It’s not a belief in black swans or intelligence if it allows one to hold more long gdp assets than any other portfolio construction

So by including long vol assets, the overall portfolio vol is theoretically dampened enough to allow an investor to leverage a higher point on the capital market line without loosing risk efficiency (sharpe)?

Think it’s more subtle than that. It’s negatively correlated with the portfolio, but the negative correlation isn’t the point. The point is that the highly convex payoff in bad states more than makes up for the drag on returns in good states.