A sting in the tail

After recent financial turmoil, market participants are thinking much more rigorously about ways to protect themselves against the possibility of rare but extreme events. However, effectively hedging tail risk is not straightforward. By Mark Pengelly

When asked what posed the greatest challenge for a statesman, former UK prime minister Harold Macmillan is reported to have responded: “Events, my dear boy, events.” The same could be said for risk managers, especially when extreme events prove so tough to accurately forecast.

Truly disastrous market shocks have been in rather short supply, making it exceptionally difficult to estimate the probability of future extreme events with any degree of precision. Recent periods of marked turbulence