Tail Risk Hedging Performance: Measuring What Counts

The authors discuss the importance of using proper metrics for measuring the historical performance of tail risk hedging portfolios in particular and for any strategy with levered payoffs in general. It is their view that simply using historical compounded returns when the payoffs may be multiples of the investment and ignoring the timing and magnitude of cash flows can potentially paint an inaccurate picture, sometimes grossly so, of the economic value of such strategies. To obtain a more accurate picture that is consistent with the objectives of such strategies, the timing and magnitude of cash flows should be included when analyzing their impact on portfolio construction. Although the correct quantitative metrics are obviously critical in measuring the efficacy and reliability of tail hedging strategies, the importance of subjective metrics, ease of implementation, flexibility, and the relevance to underlying objectives of investors is equally important.