In your shorts

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  • Here’s a pretty good article on asymmetric risk. It provides an entering wedge into understanding the delusional nature of hedge funds. Consider…

    Almost, all financial derivatives display asymmetric payoffs. All sold (short) option positions and sold (short) derivatives positions – something that banks, financial institutions, hedge funds and even corporations engage in regularly these days – are negatively skewed bets. These short portfolio positions will produce negative skew for the trader. He will be fooled by the variance (volatility) of the process, as the observed variance (volatility) would be lower than the true variance most of the time. This would mean the more the skewness in the distribution (of the portfolio) the more the variance will be concentrated in a small slice of time and for most part it will generate steady returns. And the trader will think that he is making money, albeit in small proportions but steadily. And then after a while – could be a long wait – the true variance will wipe out all those gains.

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