A Hedge By Any Other Name
May 14, 2012 3 Comments
I don’t understand the point of Ritholtz’s “Everything is a Hedge”, parts of it read like dreamlike musings. Was he drunk when he wrote it?
First, what is a hedge? [...] Looking at the question a little differently, what isn’t a hedge? There is always the other side of the trade, and that side (if not position) is what you can theoretically claim to be hedging. Hence, for a huge bank with trillions on its book, there is the rationale that any trade, any position, any financial transaction, is potentially a hedge against some other position the bank is holding.
Look, if a bank had only one position on its books, and then added to it, then of course by no logic could anyone claim that add to be a ‘hedge’. Similarly, if a bank simply doubled all its positions, by no logic could anyone claim that to be a ‘hedge’. The real-world problem we find though is that balance sheets are large and complex, and so yes Barry Ritholtz, unraveling and determining what is a hedge, or what hedges what, at which level of aggregation, etc. can be what you might call a hard problem, not easily resolvable within the confines of a blog post. (Besides, the real problem with JPM CIO’s trade appears to be that it wasn’t enough of a hedge!)
This stuff is hard and none of us is really in a position to say yea or nay without seeing JP’s actual risk and in particular what their CIO was trying to hedge. The subtext of Ritholtz’s post is that this frustrates him because he didn’t want to have to think about any of that. I sympathize, of course. But to go to the other extreme and imply, using Shakespeare (?), that a hedge can only be “a position taken in order to [sic; I guess he means 'offset'] the risk of a specific trade” is bizarre. This ‘specific trade’ standard appears to have been cooked up by bloggers and the like, who find it more convenient to think about trades one by one, and didn’t think there’d be any aggregating on the test. I had assumed Ritholtz would know better (not sure why).
Meanwhile, in other news, the Tchir conjecture that maybe JPM CIO doesn’t have this position at all anymore, and is really doing some sort of giant media head-fake rope-a-dope cool trade strategy, has lost plausibility for me with the first firings.