Cross-Asset Market Stress and Hedging Discussed at RMC Europe by Matt Moran and Jim Bittman

This morning at CBOE’s inaugural Risk Management Conference – Europe, Mr. Abhinandan Deb, Director of Equity Derivatives Research – Europe for Bank of America Merrill Lynch (BAML), delivered a presentation on “Mapping Cross-Asset Financial Stress and Hedging Macro Portfolios”

BACKGROUND. In recent years many investors have become more concerned about higher correlations and cross-asset market stress; for more background please see yesterday’s blog on “Higher Correlations and Diversification Challenges [link to



In his presentation, Mr. Abhinandan Deb covered a number of points, including the following:

1. Markets are more correlated today than ever; there is a need to track and understand risks in asset classes outside one’s comfort zone.

2. Despite high correlations, markets still price forward-looking risk differently; there could be opportunities in cheap options and potentially mispriced hedges.

3. BAML is introducing the Global Financial Stress Index (GFSI), a cross-asset risk indicator that attempts to identify the leading indicators of stress. The GFSI index series breaks stress down into subindices and attempts to measure the demand for hedging among the component asset classes. The proprietary GFSI index series measures – (a) Risk – cross-asset measures of volatility, solvency, and liquidity risk; (b) Hedging demand implied by equity and FX skew, and (c) Investor appetite for money markets and aversion from risky assets. GFSI may have potential to identify cheap hedges and relative value opportunities.

Mr Deb talked about four steps for designing a cost-effective hedging strategy:

(1) identify risk assets that respond most consistently to stress events.(2) determine the relative expected asset performance during a stress event, (3) estimate cost of hedging and (4) overlay hedge cheapening strategies.

One of many strategies that was discussed during this 1 1/4 hour presentation was a VIX calendar strangle (long a 3 month out-of-the-money VIX put, and long a 4 month VIX call, roll every 3 months).

Matt Moran

Jim Bittman