A Hedge By Any Other Name
May 14, 2012, 8:28 am
Filed under: Uncategorized

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.

3 Comments so far
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My explicit statement was “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. ” Hence, they can claim they are putting on a specific hedging trade when they are not.

If this trade was truly a hedge, they should have paired it versus the underlying position and marked them together — the $2B loss should have been offset by the gains of the underlying trade, and they could have marked to market the entire position as flat.

This trade was a bet on Corporate Commercial loans, which is in fact a huge chunk of JPM’s business. That’s not a hedge, its a doubling down.

Comment by Barry Ritholtz

1. any trade is potentially a hedge – absolutely correct! That is why when evaluating a claim that this or that trade was a hedge, it matters how they were aggregating, and which collection of position(s) their CIO was mandated to hedge. But this is not the same thing as saying that if we define hedge to include this trade, then ‘all trades are hedges’ and the concept is meaningless. no matter how expansively we defined hedge, there are clearly some situations where it could never apply, as i illustrated.

2. yes, they can lie about its being (intended as) a hedge. anyone can lie about anything. To truly know this you’d need to have details of their risk (or get an insider to tell you i guess).

3. what are you thinking of as ‘the’ underlying position that they should have ‘paired’ it with? you’re still seemingly thinking in terms of a one trade-one hedge concept, as if risk is never aggregated. I think all else equal we’d want banks to keep track of their aggregate risks?

4. the fact that the hedge lost money without a markup somewhere else could mean (like you say) that it ‘wasn’t really’ a hedge. Or it could just mean that it was a dumb hedge. To truly know this…well, see #2. But in the event, Dimon has come out and said flat-out that it was a dumb hedge, and they have already paid dearly in reputation, market cap (not to mention bigshot execs losing jobs) so his saying as much was clearly against interest. Why would we not apply Occam’s razor and take him at his word that they thought this position was a good hedge, and were retarded in so thinking?

5. Of course I tend to agree that the line between hedge and risk-trade can be fuzzy (and that different actors can see the same trade differently). But trying to draw all these definitive conclusions based on what little is (publicly) known seems very reductive, an attempt to fit concepts like “hedge” into very tiny boxes, which was my main point above.

5. re: doubling down, you’re a bit behind. No one thinks JPM CIO’s position consisted solely of a long, that was one component (the one most highly publicized in April) of what was presumably a more complicated long-short trade package full of various bases etc.

thanks for stopping by – best,

Comment by Sonic Charmer

[…] Pretty much, yes!  Which is exactly why talk of what’s a hedge and what’s not a hedge is a diversion.    I somehow missed the existentialism of Barry’s conclusion: “And once you define everything as a hedge, well then, nothing is a hedge,”  but let’s move on. (Or, you can read Sonic Charmer’s reaction to Barry’s post). […]

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